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THE    BANKING  &  CURRENCY 


PROBLEM 
IN    THE    UNITED    STATES 


BY 


VICTOR    MORAWETZ 


'<,i'jji'i^|jy,Mu~.jj.,j,w.reB^ 


NORTH  AMERICAN  REVIEW  PUBLISHING  CO. 
Franklin      Square,      New      York,     N.    Y. 

M  c  M  I  X 


Copyright,  1909,  by 
The  North  Amekican  Review  Publishing  Co. 

All  rights  reserved. 
Published  January,  1909. 


CONTENTS 

PAGE 

The  Problem i 

Causes  of  "Money  Stringency" 7 

The  Creation  of  Bank  Credits 12 

Bank  Reserves  and  their  Character 15 

Bank  Reserves  and  Liabilities  in  the  United  States  20 

Increase  of  Reserve  Money 22 

Maintenance   of  the   Gold   Standard   and   of  Cash 

Payments 25 

Issue  of  Bank-Notes 27 

Effects  of  Issuing  Bank-Notes 28 

Difference  between  Notes  and  Other  Instruments  32 

Regulation  of  the   Banks       34 

Insufficient    Reserves     and     Over- Expansion     of 

Credits 36 

Minimum  Reserves  of  National  Banks 38 

Over-Expansion  vi^ith  Regard  to  the  General  Credit 

Situation 43 

Central  Regulation  Necessary 45 

The  Central  Bank  Plan 50 

Central  Bank  Not  Practicable  in  the  United  States  52 

Independent  Bank-Note  Issues 55 

The  Currency  Situation  in  the  United  States  .     .  58 


CONTENTS 


PAGE 


r^igulation  by  taxation 62 

Regulation  by  Government  Note  Issue      ....  66 

The  European  System  of  Commercial  Credits     .     .  69 

Guarantee  of  Bank  Deposits 72 

State  Banks  and  Trust  Companies 79 

How  Central  Regulation  can  be  Secured     ...  84 

Plan  for  Central  Regulation  in  the  United  States  87 

Branches  and  Agencies 89 

Meetings  of  the   Board   of   Managers,  etc.     .     .  90 

Limit  of  Note  Issues  under  Plan 90 

Redemption  Fund  under  the  Plan 91 

Separate  Reserves  for  the  Notes 94 

Operation  of  the  Plan  Illustrated 97 

Uniform  or  Separate  Note  Issues  of  the  Banks  102 

Security  of  the  Notes 107 

Collateral  Security no 

Protection  of  United  States  Bond  Values     .     .  114 

Taxation  of  Notes  Under  the  Plan 114 

Existing  Bond-Secured  Notes 117 


THE    BANKING    AND    CURRENCY 

PROBLEM 

IN   THE   UNITED    STATES 


THE 
BANKING     AND     CURRENCY 

PROBLEM 
IN     THE     UNITED     STATES 

THE    PROBLEM 

For  many  years  the  country  has  suffered  from 
recurring  periods  of  severe  financial  stringency. 
During  these  periods  interest  rates  have  been  ex- 
cessively high,  and  business  men  have  lost  heavily 
through  inability  to  obtain  necessary  loans  and 
discounts  from  the  banks.  At  times  wide-spread 
panic  and  general  suspension  of  payments  by 
the  banks  have  resulted  from  runs  upon  a  few 
banks  by  their  depositors.  Only  recently  we  have 
emerged  from  a  disastrous  panic  which  forced  the 
suspension  of  nearly  all  the  banks,  and,  by  the 
destruction  of  confidence  and  credit,  arrested  busi- 
ness activity  throughout  the  country  and  caused 
vast  losses  to  the  people.     This  panic  brought  to  a 


THE  BANKING  AND  CURRENCY  PROBLEM 

violent  close  a  period  of  unprecedented  prosperity, 
in  which  manufacturers  and  merchants  had  not 
unduly  expanded  their  obligations  for  the  purpose 
of  carrying  unsold  stocks  of  goods.  On  the  con- 
trary, production  had  been  barely  able  to  keep 
pace  with  demand  for  the  products  of  industry. 

Such  extraordinary  financial  disturbances  do 
not  occur  in  other  civilized  countries.  They  in- 
dicate that  something  is  seriously  wrong  with  the 
system  of  banking  and  currency  in  the  United 
States.  The  National  Monetary  Commission  was 
created  for  the  purpose  of  devising  a  remedy  that 
will  prevent  similar  disturbances  in  the  future. 

When  a  doctor  is  called  in  to  prescribe  for  a 
patient,  his  first  step  must  be  to  discover  the 
disease  that  causes  the  symptoms  of  which  the 
patient  complains.  Similarly,  before  the  Com- 
mission can  intelligently  prescribe  remedies  it  must 
ascertain  what  is  wrong  with  our  present  financial 
system.  The  first  step  must  be  to  discover  the  true 
cause  of  our  financial  troubles.  The  next  step 
should  be  to  devise  a  remedy  that  will  remove  the 
existing  cause  of  trouble,  but  will  not  itself  intro- 
duce a  new  source  of  trouble  or  of  danger. 

Occasional  bank  failures  and  runs  upon  isolated 
banks  by  panic-stricken  depositors  do  not  prove 
that  anything  is  wrong  with  our  system  of  banking 
and  currency.     A  bank  may  become  insolvent  and 


IN  THE  UNITED  STATES 

may  fail  in  consequence  of  dishonesty  or  incom- 
petence of  its  officers ;  and  the  depositors  of  a  bank 
may  become  panic-stricken  in  consequence  of  some 
false  report,  though  there  be  nothing  wrong  with 
their  bank.  No  system  and  no  legislation  can 
make  bank  managers  honest  and  prudent,  or  guard 
against  the  penalties  of  dishonesty  and  imprudence, 
and  no  system  can  enable  a  bank  to  keep  in  its 
vaults  enough  cash  to  pay  off  all  its  depositors  at 
once  if  they  make  a  run  upon  the  bank.  But  if 
the  failure  of  one  bank  or  of  several  banks,  or  a 
panic  among  their  depositors,  results  in  the  sus- 
pension of  practically  all  the  banks,  as  happened 
recently,  something  must  be  radically  wrong  with 
the  whole  system,  or  in  the  method  of  conducting 
the  banking  business  in  the  United  States.  A 
system  of  banking  that  fails  to  make  adequate  pro- 
vision against  unexpected  contingencies,  such  as 
the  suspension  of  one  bank  or  of  several  banks — a 
system  that  works  satisfactorily  only  in  financial 
fair  weather — clearly  is  unsound  and  inadequate. 
Such  a  system  is  as  unsafe  as  a  ship  that  can  sail 
only  in  fair  weather  and  is  likely  to  founder  during 
the  first  storm.  We  have  in  the  United  States  a 
banking  system  that  in  normal  times  has  served  us 
well — a  satisfactory  system  of  fair-weather  bank- 
ing. What  we  need  is  a  system  that  will  carry  us 
safely  through  periods  of  financial  stress  and  storm. 

3 


THE  BANKING  AND  CURRENCY  PROBLEM 

The  immediate  cause  of  a  stringency  in  the 
money-market,  of  excessive  interest  rates,  of  in- 
abiHty  of  the  banks  to  grant  the  credits  needed  for 
the  transaction  of  the  legitimate  business  of  the 
country,  or  of  a  general  suspension  of  cash  pay- 
ments by  the  banks,  is  that  the  banks  either  have 
expanded  their  deposit  liabilities  or  have  reduced 
their  reserves  beyond  the  limit  of  safety.  It  is 
obvious  that  if  the  banks  keep  their  reserves  of 
cash  large  enough  in  relation  to  their  deposit  lia- 
bilities, or  (putting  it  the  other  way)  if  they  keep 
their  deposit  liabilities  small  enough  in  relation  to 
their  cash  reserves,  so  that  at  all  times  they  will 
be  able  to  pay  cash  to  depositors  who  demand  cash, 
the  banking  situation  as  a  whole  will  be  safe. 

But  to  keep  the  banks  in  a  safe  condition,  and 
to  prevent  bank  failures  and  panics,  is  only  part  of 
the  problem.  It  is  necessary,  also,  to  devise  a 
system  of  banking  that  will  meet  the  require- 
ments of  trade  and  commerce.  The  business  of 
the  world  is  based  on  credit,  and  the  banks  are 
the  instruments  by  which  this  credit  is  created. 
Modern  enterprise  and  business  activity  would  be 
utterly  impossible  without  an  enormous  volume 
of  bank  credits.  The  aggregate  deposit  liabilities 
of  the  National  banks  alone  amount  to  more  than 
$5,000,000,000,  and  their  loans  and  discounts 
amount  to  about  that  sum,   while  the  aggregate 

4 


IN  THE  UNITED  STATES 

individual  deposit  liabilities  of  all  the  banks  and 
trust  companies  in  the  United  States,  including 
the  National  banks,  amount  to  more  than  $13,- 
000,000,000,  and  their  loans  and  discounts  to  more 
than  $10,500,000,000.  These  enormous  volumes  of 
bank  credits  cannot  be  diminished  without  dimin- 
ishing the  business  prosperity  of  the  country;  and 
unless  the  volume  of  bank  credits  can  keep  on  ex- 
panding .still  further  there  must  be  a  check  to  the 
future  development  of  the  country  and  to  its  busi- 
ness prosperity. 

Our  banking  troubles  cannot  be  prevented  by 
the  simple  means  of  compelling  the  banks  to  keep 
larger  minimum  reserves  or  by  restricting  their 
power  to  grant  credits.  All  possibility  of  bank 
failures  could  be  prevented  by  abolishing  the  banks 
altogether,  but  that  would  be  killing  the  patient 
in  order  to  destroy  the  disease.  The  risk  of  bank 
failures  and  of  panics  might  be  reduced  to  a  mini- 
mum by  requiring  the  banks  to  keep  on  hand  very 
much  larger  reserves  of  money  than  now  in  pro- 
portion to  their  deposit  liabilities,  but  this  would 
merely  compel  the  banks  to  reduce  their  loans  and 
their  deposit  liabilities  so  as  to  bring  about  the 
required  relation  between  the  reserves  and  the  de- 
posit liabilities.  From  self-interest  the  banks  make 
their  reserves  as  large  as  possible,  because  the 
amount  of  their  reserves  determines  the  amount  of 

5 


THE  BANKING  AND  CURRENCY  PROBLEM 

credits  they  can  grant  and  consequently  the  amount 
of  money  they  can  earn  by  making  loans  and  dis- 
counts, A  law  requiring  the  banks  to  keep  larger 
reserves  in  proportion  to  their  deposit  liabilities 
would  not  enable  them  to  increase  their  reserves 
by  a  dollar;  it  would  merely  contract  their  power 
to  grant  credits,  and  this  contraction  of  the  power 
to  grant  credits  would  create  a  financial  stringency 
and  raise  interest  rates.  If  carried  too  far,  it 
would  arrest  business  and  destroy  enterprise. 
Safety  of  the  banking  situation  undoubtedly  must 
be  secured,  but  it  is  no  less  important  to  provide 
for  the  largest  volume  of  bank  credits  consistent 
with  safety,  so  that  business  prosperity  may  not 
suffer.  The  problem,  therefore,  is  not  merely  to 
make  banking  safe  and  to  prevent  future  panics; 
the  problem  is  to  devise  a  system  that  will  permit 
of  the  largest  possible  expansion  of  bank  credits 
consistent  with  safety. 

No  system  of  banking  and  currency  can  be  sound 
or  prove  of  lasting  value  unless  it  shall  accord  with 
the  elementary  principles  of  economic  science  ap- 
proved by  the  leading  financial  experts  of  the 
world.  Failure  to  realize  the  full  force  and  effect 
of  these  established  elementary  principles,  and  to 
apply  these  principles  correctly  and  consistently, 
has  been  the  source  of  many  popular  fallacies  that 
have  prevailed  in  the  United  States.     It  is  desir- 

6 


IN   THE   UNITED  STATES 

able,  therefore,  in  discussing  the  banking  and 
currency  problem,  to  state  and  to  explain  briefly 
some  of  these  elementary  principles,  although 
they  may  be  familiar  to  students  of  economic 
science. 


Causes  of  **  Money  Stringency  ** 

The  entire  currency  of  the  country  consists  of 
approximately  three  thousand  million  dollars.  Of 
this  sum  less  than  three-fifths  is  ever  in  actual  cir- 
culation among  the  people.  A  little  more  than 
one-third,  or  approximately  twelve  hundred  million 
dollars,  is  held  by  the  banks  and  trust  companies 
as  a  reserve  for  the  payment  of  their  depositors  on 
demand,  and  more  than  two  hundred  million  dol- 
lars are  held  by  the  Government.  The  aggregate 
amount  of  currency  actually  used  by  the  people  of 
the  United  States  as  a  circulating  medium — that 
is  to  say,  the  aggregate  amount  carried  in  their 
pockets,  or  kept  in  cash-drawers  or  in  safes  for  use 
in  business,  or  hoarded  in  secret  places — fluctuates 
from  time  to  time.  The  amount  thus  used  as  a 
circulating  medium  by  the  people  at  any  one  time 
depends  wholly  upon  the  will  of  the  people  and 
upon  their  need  of  a  circulating  medium.  No  cur- 
rency plan  would  in  the  least  increase  or  diminish 
the  amount  of  currency  actually  used  by  the  peo- 

7 


THE  BANKING  AND  CURRENCY  PROBLEM 

pie  as  a  circulating  medium.  Any  one  who  has  a 
bank-account,  or  who  has  property  for  sale,  or 
who  has  credit  enabling  him  to  borrow,  always  can 
obtain  currency  from  the  banks,  unless  they  break 
their  contracts  with  depositors  and  violate  their 
legal  duty  by  refusing  on  demand  to  pay  in  cur- 
rency checks  of  their  depositors.  Though  the  cur- 
rency of  the  country  were  doubled  in  volume,  this 
would  not  put  a  dollar  into  the  pockets  of  any  man, 
except  as  received  by  him  in  payment  for  labor  or 
property,  or  as  a  gift,  and  the  amount  of  currency 
actually  in  circulation  would  not  be  increased  by  a 
dollar.  People  would  not  carry  in  their  pockets 
more  currency  than  at  present.  On  the  other 
hand,  whenever  the  currency  in  circulation  exceeds 
the  amount  which  the  people  want  to  carry  in  their 
pockets,  or  to  keep  in  their  tills  and  in  cash-boxes, 
or  to  hoard,  this  excess  will  be  deposited  in  the 
banks  and  trust  companies.  The  reserves  of  the 
banks  and  trust  companies  are  merely  the  surplus 
of  currency  left  over  after  supplying  these  wants 
of  the  people  for  currency  as  a  circulating  medium. 
Therefore,  it  follows  that  as  the  amount  of  currency 
used  for  actual  circulation  fluctuates,  so  also  the 
bank  reserves  will  fluctuate,  except  so  far  as  these 
fluctuations  may  be  compensated  by  the  importa- 
tion of  gold,  or  by  the  issue  of  bank-notes,  as 
hereafter  will  be  pointed  out. 

8 


IN   THE  UNITED  STATES 

Various  causes  produce  these  fluctuations  in  the 
amount  of  currency  used  as  a  circulating  medium. 
When  business  is  active  and  labor  throughout  the 
country  finds  profitable  employment,  more  money 
is  kept  in  circulation  to  pay  wages  and  to  make 
other  cash  payments,  and  people  carry  more  pocket- 
money  than  in  dull  times.  Usually  about  Christ- 
mas-time there  is  a  special  demand  for  currency  on 
account  of  the  requirements  of  holiday  trade.  But 
the  largest  fluctuation  is  caused  annually  by  the 
requirements  of  the  West  and  South  for  cash  to 
make  payments  incidental  to  harvesting  and  to 
moving  the  crops.  It  is  difficult  to  determine  ac- 
curately the  extra  amount  of  cash  needed  for  this 
purpose,  but  it  is  estimated  that  to  move  the  crops 
there  is  required,  annually,  aproximately  two  hun- 
dred million  dollars,  or  about  7  per  cent,  of  the 
entire  currency.  After  a  few  months  the  extra 
amount  of  currency,  being  no  longer  needed  to 
move  the  crops,  is  returned  to  the  banks  and  trust 
companies  and  again  becomes  part  of  their  reserves. 

As  the  whole  amount  of  currency  used  as  a  cir- 
culating medium  by  the  people  never  exceeds  three- 
fifths  of  the  entire  currency  in  the  country,  it  is 
obvious  that  the  currency  is  ample  for  the  uses  of 
the  people  as  a  circulating  medium.  When  it  is 
said  that  money  is  tight,  or  that  a  stringency  exists 
in  the  money-market,  this  does  not  mean  that  there 

9 


THE  BANKING  AND  CURRENCY  PROBLEM 

is  insufficient  currency  in  the  country  to  meet  the 
needs  of  the  people  for  a  circulating  medium.  It 
means,  really,  that  people  cannot  obtain  loans  and 
discounts  from  the  banks,  because  the  banks  are 
unable  to  grant  further  credits,  their  reserves  of  law- 
ful money  being  insufficient.  It  means  either  that 
the  banks  and  trust  companies  have  expanded  their 
deposit  liabilities  in  relation  to  their  reserves  to  the 
limit  of  safety,  or  to  the  legal  limit,  and  that  they 
cannot  lend  their  credit  any  further  by  the  creation 
of  deposit  liabilities,  or  else  that  they  feel  com- 
pelled to  call  in  loans  so  as  to  increase  their  reserves 
or  to  reduce  their  deposit  liabilities.  It  does  not 
mean  that  the  people  cannot  have  all  the  currency 
they  want  for  circulation,  unless,  as  recently,  the 
banks  actually  suspend  cash  payments.  Even 
when  the  banks  suspend  cash  payments,  and  there 
appears  to  be  a  currency  famine,  as  in  the  recent 
panic,  the  real  cause  of  the  trouble,  and  the  source 
of  danger,  is  not  the  inability  of  depositors  to  obtain 
currency  from  the  banks.  This  inability  to  obtain 
currency  was  an  inconvenience,  but  not  very  serious, 
because,  generally,  debts  could  be  paid  by  check. 
The  seriousness  of  the  panic  arose  from  the  fact  that 
the  banks,  having  expanded  their  deposit  liabilities 
in  relation  to  reserves  beyond  the  limit  of  safety, 
were  compelled  to  call  in  loans  that  could  not  be 
paid  immediately  without  enormous  sacrifices,  and 


IN  THE  UNITED  STATES 

were  compelled  to  refuse  to  make  loans  and  to  grant 
credits  for  legitimate  and  necessary  business  pur- 
poses. 

Tight  money,  or  a  stringency  of  the  money- 
market,  whether  general  or  sectional,  may  result 
from  one  or  more  of  the  following  causes — viz., 
(i)  the  banks  may  be  unable  to  grant  further 
credits,  or  they  may  be  compelled  to  reduce  the 
amount  of  their  credits,  because  their  reserves  have 
been  reduced  by  unusual  withdrawals  of  lawful 
money,  as  may  happen  when  a  large  amount  of 
money  is  used  to  pay  duties  and  other  taxes  and  is 
locked  up  by  the  Government,  or  when  a  large 
amount  of  currency  is  withdrawn  either  for  use  as  a 
circulating  medium  in  the  West  and  South  to  "  move 
the  crops,"  or  to  be  hoarded  by  panic-stricken  de- 
positors, or  when  a  large  amount  of  gold  is  drawn 
for  export;  or  (2)  the  banks  may  be  unable  to  grant 
additional  credits,  because  through  extraordinary 
activity  in  business  the  aggregate  amount  of  credit 
desired  has  been  increased  to  the  limit  permitted 
by  their  reserves  of  lawful  money ;  or  (3)  the  persons 
who  desire  credit  may  be  unable  to  furnish  satis- 
factory assurance  or  security  to  such  banks  as  may 
be  able  still  to  grant  credits. 

It  is  obvious,  then,  that  our  currency  question 
is  really  a  question  of  bank  credits  and  bank  re- 
serves.    The  problem  is,  while  preventing  any  un- 

II 


THE  BANKING  AND  CURRENCY  PROBLEM 

safe  expansion  of  credits  or  the  issue  of  any  unsafe 
currency,  to  find  a  way,  (i)  to  avoid  a  depletion  of 
bank  reserves  and  the  consequent  large  reduction 
of  bank  credits  in  times  when  lawful  money  is  with- 
drawn to  pay  taxes  and  is  locked  up  by  the  Govern- 
ment, or  when  lawful  money  is  largely  withdrawn 
for  use  as  a  circulating  medium  to  move  the  crops, 
or  to  be  hoarded;  and  (2)  to  enable  the  banks,  in 
times  of  great  business  activity,  to  expand  their 
deposit  liabilities  and  their  loans  and  discounts, 
and  also  adequately  to  increase  their  reserves  of 
lawful  money. 


The  Creation  of  Bank  Credits 

The  National  banks  owe  to  their  depositors  in  the 
aggregate  six  or  seven  times  the  aggregate  amount 
of  currency  held  by  these  banks.  The  banks  and 
trust  companies  of  the  United  States,  including  the 
National  banks,  collectively  owe  to  their  individual 
depositors  (not  including  deposits  of  one  trust  com- 
pany or  bank  in  another  trust  company  or  bank) 
more  than  thirteen  thousand  million  dollars,  pay- 
able on  demand,  this  sum  being  about  twelve  times 
the  aggregate  amount  of  currency  held  by  all  the 
banks  and  trust  companies,  or  more  than  four  times 
the  entire  currency  of  the  United  States. 

In -dealing  with  the  banking  and  currency  prob- 
12 


IN   THE  UNITED  STATES 

lem,  it  is  of  paramount  importance  to  bear  in 
mind  that,  in  large  part,  these  so-called  deposits 
in  the  banks  and  trust  companies  are  created  with- 
out the  actual  deposit  of  any  money.  The  ex- 
pression "bank  deposits"  often  is  misleading  to 
those  who  are  not  familiar  with  the  actual  course 
of  banking  operations.  In  very  large  part  the  de- 
posit liabilities  of  the  banks  and  trust  companies 
are  created  by  mere  book  entries  representing  loans 
of  the  credit  of  the  banks  for  a  consideration  re- 
ceived by  them  in  the  form  of  interest. 

As  a  rule,  when  a  borrower  applies  to  a  bank  for 
a  loan  he  does  not  want  to  carry  away  the  amount 
of  the  loan  in  currency.  What  he  wants  is  a  credit 
so  that  from  time  to  time  in  the  course  of  his  busi- 
ness he  can  draw  his  checks  upon  the  bank.  Ac- 
cordingly, the  bank  discounts  the  borrower's  note, 
and  credits  his  deposit  account  with  the  amount 
of  the  note,  less  the  interest,  as  though  he  had 
actually  deposited  that  sum,  although  in  fact  he 
never  deposited  a  dollar  in  money.  The  borrower 
receives  from  the  bank  only  a  deposit  credit,  and 
usually  there  is  a  tacit  or  expressed  understanding 
that  he  will  not  draw  against  this  credit  except 
from  time  to  time,  in  the  course  of  his  business, 
and  that  as  long  as  he  continues  to  be  a  customer 
of  the  bank  he  will  allow  a  reasonable  balance  to 
remain  undrawn.     The  bank  receives  no  money, 

13 


THE  BANKING  AND  CURRENCY  PROBLEM 

but  by  means  of  a  book  entry  its  nominal  deposits 
are  increased  by  the  amount  of  the  loan,  less  the 
interest,  which,  commonly,  is  deducted  in  advance. 
The  real  transaction  is  simply  an  exchange  of  credits 
between  the  bank  and  the  borrower.  If,  however, 
the  transaction  should  take  the  form  of  an  actual 
payment  of  money  to  the  borrower,  this  money 
soon  would  be  deposited  again  in  the  banks,  either 
by  the  borrower  or  by  other  persons  receiving  it  in 
the  course  of  business,  and  thereupon  from  time  to 
time  the  same  money  could  be  loaned  out  again  and 
be  redeposited.  The  deposit  liabilities  of  the  banks 
would  be  increased  on  each  occasion  when  the 
money,  after  having  been  paid  out  by  the  banks  by 
way  of  a  loan,  is  returned  to  them  as  a  deposit. 

By  these  processes  the  deposit  liabilities  of  the 
banks  may  be  increased  almost  indefinitely  without 
increasing  the  amount  of  money  held  by  them.  The 
only  absolute  limitation  is  that  imposed  by  the 
necessity  of  holding  as  a  reserve  an  amount  of  money 
sufficient  to  supply  depositors  with  the  sums  they 
are  likely  to  withdraw  for  use  as  currency,  and  to 
enable  the  banks  to  settle  with  one  another  such 
balances  as  cannot  be  settled  by  exchanges  of 
checks  through  the  clearing-houses.  In  large  part 
the  business  of  banking  consists  of  making  loans 
and  of  discounting  notes  payable  with  interest  at 
future  dates  in  consideration  of  the  assumption  of 

14 


IN  THE  UNITED  STATES 

deposit  liabilities  payable  on  demand,  without  in- 
terest or  at  a  low  rate  of  interest,  it  being  understood 
that  a  large  part  of  these  deposit  liabilities  always 
will  be  allowed  to  remain  unpaid. 

The  business  of  the  country  cannot  be  carried 
on  without  the  use  of  a  stupendous  amount  of  credit. 
Bank  credit  serves  this  purpose  where  the  credit 
of  individuals  would  not  be  acceptable.  The  great 
service  rendered  by  the  banks  is  that  they  furnish 
in  acceptable  form  the  vast  amount  of  credit  which 
is  essential  to  carry  on  the  business  of  the  country. 


Bank  Reserves  and  thefr  Character 

While  a  very  large  part  of  the  aggregate  deposit 
liabilities  of  the  banks  always  is  allowed  to  remain 
unpaid,  and  while  the  great  bulk  of  the  transactions 
of  the  banks  can  be  effected  by  set-off  through  the 
clearing-houses  without  the  actual  delivery  of  cur- 
rency, yet  prudence  requires  every  bank  and  every 
financial  institution  to  keep  on  hand  sufficient  cur- 
rency to  enable  it  to  meet  all  demands  for  currency 
that  are  likely  to  be  made  upon  it,  having  regard 
to  all  the  prevailing  conditions.  In  England  the 
amount  of  currency  that  the  banks  must  reserve  in 
their  vaults  to  meet  their  deposit  liabilities  is  not 
fixed  by  statute,  but  is  left  to  the  judgment  of  the 
banks.     In  the  United  States  the  laws  require  the 

15 


THE  BANKING  AND  CURRENCY  PROBLEM 

National  banks  and  the  various  State  banks  and 
trust  companies  to  keep  on  hand  certain  minimum 
reserves  proportionate  to  their  deposit  liabiHties. 
The  requirements  of  the  laws  as  to  minimum  re- 
serves vary  widely  with  respect  to  the  different 
classes  of  banks  and  trust  companies,  and  each 
State  has  prescribed  its  own  rules. 

The  character  and  sufficiency  of  bank  reserves 
must  be  considered  with  regard  to  the  banking 
situation  as  a  whole  as  well  as  with  regard  to  the 
affairs  of  each  separate  bank. 

Thus,  a  deposit  claim  of  one  bank  against  an- 
other bank — that  is  to  say,  its  right  to  call  upon 
such  other  bank  for  the  payment  on  demand  of  a 
sum  of  money — may  be  treated  as  a  reserve,  if  we 
leave  out  of  consideration  the  position  of  the  banks 
collectively  and  the  general  banking  situation. 
But,  obviously,  the  liability  of  a  bank  to  pay  money 
to  another  bank  would  not  increase  the  collective 
ability  of  all  the  banks  to  pay  all  their  depositors 
and  would  not  in  the  least  strengthen  the  gen- 
eral financial  situation.  When  a  particular  bank 
strengthens  its  own  reserve  by  drawing  upon  its 
deposit  with  another  bank,  it  weakens  to  the  same 
extent  the  reserve  of  the  bank  upon  which  it  draws. 
Therefore,  when  there  is  a  general  money  stringency 
— that  is  to  say,  when  the  banks  throughout  the 
country  have  expanded  their  credits  to  the  limit 

i6 


IN  THE  UNITED  STATES 

of  safety — the  deposits  of  certain  banks  in  other 
banks  are  not  good  as  reserves,  and  do  not  in  the 
least  strengthen  the  general  banking  situation. 
We  had  an  illustration  of  this  during  the  recent 
panic,  when  the  credit  situation  had  become  strain- 
ed throughout  the  entire  country.  The  Western 
banks  having  large  deposits  with  the  New  York 
banks  began  to  draw  against  them,  thereby 
diminishing  the  reserves  of  the  New  York  banks; 
but  as  the  latter,  quite  as  much  as  the  Western 
banks,  needed  their  reserves,  the  money  stringency 
in  New  York  soon  reached  the  breaking-point,  and 
all  the  New  York  banks  suspended  cash  payments. 
Under  these  circumstances  the  deposits  of  the 
Western  banks  were  of  no  use  to  them  as  reserves. 
Similarly,  bank-notes  may  be  treated  as  a  reserve, 
if  the  position  of  the  bank  holding  such  notes  be 
considered  without  regard  to  the  general  banking 
situation;  but,  having  regard  to  the  situation  of  all 
the  banks,  it  is  clear  that  such  notes  are  not  good 
as  a  reserve.  A  bank-note  is  merely  a  promissory 
note  payable  in  money  on  demand.  Bank  "A" 
holding  notes  of  bank  "B  "  may  consider  such  notes 
as  good  as  money  so  long  as  bank  "B"  is  solvent 
and  pays  its  obligations  on  demand;  but  it  is 
obvious  that  when  bank  "A"  obtains  money  from 
bank  "B"  by  requiring  it  to  redeem  its  notes  the 
reserves  of  bank  "B"  will  be  diminished  exactly  as 

17 


THE  BANKING  AND  CURRENCY  PROBLEM 

much  as  the  reserves  of  bank  "A"  are  increased. 
That,  having  regard  to  the  entire  banking  situa- 
tion, bank-notes  are  not  a  good  reserve  becomes 
apparent  upon  considering  the  case  of  several 
banks  exchanging  their  notes,  and  each  bank  call- 
ing upon  the  others  to  pay  their  notes  in  lawful 
money. 

As  long  as  financial  conditions  are  normal,  call 
loans  may  be  regarded  as  a  good  reserve,  because 
a  bank  can  obtain  cash  promptly  by  calling  such 
loans;  but  call  loans  do  not  strengthen  the  general 
banking  situation,  and,  therefore,  when  there  is  a 
severe  money  stringency,  they  are  not  good  as  a 
reserve.  When  a  bank  calls  a  loan,  the  borrower 
either  must  borrow  the  same  sum  from  some  other 
bank,  although  required  to  pay  a  very  high  rate  of 
interest,  or  he  must  obtain  the  required  sum  by 
selling  property,  and  in  that  event  the  purchaser 
usually  must  draw  the  money  from  the  banks. 
Therefore,  when  a  bank  strengthens  its  reserve  by 
calling  a  loan,  the  practical  effect  is  to  draw  the 
money  from  other  banks  and  pro  tanto  to  weaken 
their  reserves. 

For  similar  reasons,  as  long  as  financial  condi- 
tions generally  are  not  strained,  bonds  or  other 
securities  that  have  a  ready  market  may  serve  as  a 
reserve,  because  by  selling  such  bonds  or  securities 
a  bank  can  ol.^tain  money;  but  reserves  of  that 

i8 


IN  THE  UNITED  STATES 

character  do  not  strengthen  the  general  credit 
situation  and  are  not  available  when  most  needed 
by  the  banks  that  hold  them.  When  a  bank  sells 
securities  in  order  to  obtain  lawful  money  to  pay 
its  depositors,  the  purchaser  usually  must  draw  the 
purchase  price  from  the  banks.  The  selling  bank 
thus  would  obtain  lawful  money  by  drawing  in- 
directly from  the  reserves  of  other  banks.  There- 
fore, when  there  is  a  general  money  stringency, 
bonds  or  other  salable  securities  are  not  good  re- 
serves. During  the  recent  panic  many  of  the  banks 
and  trust  companies,  including  some  of  those  which 
failed,  owned  large  amounts  of  high-class  securi- 
ties, but  this  did  not  help  them  or  relieve  the 
general  situation,  as  the  combined  lawful  money 
reserves  of  the  banks  and  trust  companies  were 
inadequate. 

Deposits  by  banks  in  other  banks,  bank-notes, 
call  loans,  and  bonds  or  other  securities  are  not, 
properly  speaking,  bank  reserves  at  all.  They  are 
only  the  means  of  obtaining  reserve  money  for 
particular  banks  by  drawing  this  money  from  the 
reserves  of  other  banks.  In  considering  the  general 
financial  situation,  deposits  of  banks,  bank-notes, 
call  loans,  and  securities  held  by  the  banks  should 
be  disregarded.  For  the  ultimate  payment  of 
bank-deposit  liabilities  the  only  true  reserve  is 
legal-tender  money. 

19 


THE  BANKING  AND  CURRENCY  PROBLEM 

Bank  Reserves  and  Liabilities  in  the  United  States 

At  all  times  the  demand  liabilities  of  the  banks 
in  the  United  States  are  very  largely  expanded  in 
relation  to  the  reserves  of  money  held  by  them  for 
the  payment  of  these  liabilities. 

According  to  the  reports  of  the  Comptroller  of 
the  Currency,  on  August  22,  1907,  and  on  November 
27,  1908,  the  demand  liabilities  of  the  National 
banks  alone  were  approximately  as  follows,  omit- 
ting all  liabilities  of  National  banks  to  other  Na- 
tional banks: 

August  12,  1907.  No»einber  17, 1908. 

6,544  Banks.  6,865  Banks. 

Individual   deposits $4,319,035,402     $4,720,284,640 

Due  to  State  banks  and  bank- 
ers, trust  companies  and 
savings-banks    (net   amount)       610,652,912  812,351,826 

U.  S.  deposits  (net  amount).  .  .       156,306,310  118,348,294 

National      bank  -  notes      (net 

amount)    520,709,334  561,414,59s 

Total $5,606,703,958     $6,212,399,355 

At  the  same  dates  the  aggregate  amount  of  money 
held  by  the  banks  was  as  follows: 

August  22,  1907.  November  27,  1908, 

Specie   $531,107,750  $656,528,775 

Legal-tender  notes 170,515,782  188,230,744 

In  5-per-cent  note   redemption 

fund 27,305,679  29,809,485 

Total  reserve $728,929,211        $874,569,004 

20 


IN  THE  UNITED  STATES 

The  aggregate  collective  money  reserves  of  all  the 
National  banks  on  August  22,  1907,  amounted  to 
about  13  per  cent.,  and  on  November  27,  1908, 
to  about  14  per  cent,  of  their  collective  liabilities 
payable  on  demand,  not  including  liabilities  to 
National  banks.  The  aggregate  amount  of  gold 
and  gold  certificates  included  in  these  reserves  on 
August  22,  1907,  was  $404,799,628,  or  about  7  per 
cent.,  and  on  November  27, 1908,  was  $512,207,371, 
or  a  little  over  8  per  cent,  of  their  demand  liabil- 
ities to  others  than  National  banks. 

According  to  the  report  of  the  Comptroller  for 
1907,  the  collective  individual  deposits  of  all  the 
19,746  reporting  banks  and  trust  companies  in  the 
United  States,  including  the  National  banks,  on 
or  about  June  30,  1907,  amounted  to  $13,099,600,- 
000,  while  their  aggregate  reserves  of  cash  of  all  kinds, 
including  bank-notes,  amounted  to  $1,113,742,316. 

Thus  the  collective  cash  reserves  of  all  of  the 
reporting  banks  and  trust  companies  amounted  to 
about  8.5  per  cent,  of  their  collective  deposit  lia- 
bilities to  individuals.  On  or  about  June  30,  1907, 
the  aggregate  amount  of  gold  and  gold  certificates 
held  by  all  these  banks  and  trust  companies  was 
only  $570,692,702,  or  about  4.4  per  cent,  of  their 
aggregate  deposit  liabilities  to  individuals. 

There  are  no  reports  from  other  countries  fur- 
nishing definite  information  as  to  the  aggregate 


THE  BANKING  AND  CURRENCY  PROBLEM 

deposit  liabilities  and  aggregate  reserves  of  their 
banks,  omitting  from  the  licibilities,  as  well  as  from 
the  reserves  deposits  of  one  bank  in  another  bank 
and  bank-notes  held  by  the  banks ;  but  it  has  been 
estimated  that  the  aggregate  amount  of  gold  held 
by  all  the  English  banks  is  about  6  per  cent,  of 
their  aggregate  deposits,  not  counting  deposits  of 
one  bank  in  another  bank  or  bank-notes  held  by 
the  banks. 

The  Bank  of  England,  alone,  generally  holds  a 
reserve  of  about  50  per  cent,  of  its  deposit  liabilities, 
and  a  larger  separate  reserve  for  its  notes;  the 
Bank  of  France,  a  reser\^e  of  about  80  per  cent,  of 
its  deposit  liabilities  and  notes;  and  the  Imperial 
Bank  of  Germany,  a  reserve  of  about  40  per  cent, 
of  its  deposit  liabilities  and  notes. 


Increase  of  Reserve  Money 

As  bank  reserves  are  held  for  the  payment  of 
the  deposit  liabilities  of  the  banks,  they  should  con- 
sist of  legal-tender  money,  or  of  such  other  currency 
as  the  banks  can  require  their  depositors  to  accept. 
Similarly,  in  the  absence  of  some  stipulation  to  the 
contrary,  it  should  be  implied  that  banks  may  pay 
their  depositors  in  any  kind  of  currency  which,  by 
statute,  is  declared  to  be  good  as  a  reserve  against 
deposit  liabilities. 

29 


IN  THE  UNITED  STATES 

By  statute,  gold  coin  and  gold  certificates  of  de- 
posit, silver  coin  and  silver  certificates  of  deposit, 
and  Government  notes,  are  declared  to  be  good  as 
reserves  of  the  National  banks.  Gold  coin,  silver 
coin,  and  Government  notes  are  made  a  legal  ten- 
der for  the  payment  of  debts.  The  gold  certificates 
and  silver  certificates  are  not  made  a  legal  tender, 
but  they  can  be  issued  only  against  a  like  amount 
of  gold  and  silver  deposited  with  the  Government, 
and  are  convertible  on  demand  into  gold  coin  or 
silver  coin.  Therefore,  there  is  no  good  reason 
why  such  certificates  should  not  be  used  as  bank 
reserves  in  place  of  the  coin  itself,  which  is  legal- 
tender  money. 

Though  the  Government  notes  are  merely  promis- 
sory notes  of  the  Government,  and  though  the 
bullion  value  of  each  silver  dollar  coined  by  the 
Government  is  only  about  fifty  cents  in  gold,  both 
the  Government  notes  and  the  silver  coin  are  at 
a  parity  with  gold  coin.  The  Government  notes 
are  at  a  parity  with  gold  because  the  Government 
has  promised  to  pay  them  in  gold,  and  keeps  an 
adequate  reserve  of  gold  to  insure  their  payment 
on  demand.  While  the  Government  has  not  defi- 
nitely promised  to  redeem  the  silver  dollars  in 
gold,  yet  they  are  at  a  parity  with  gold  because 
their  supply  is  limited,  because  they  are  receivable 
for  customs,  taxes,  and  public  dues,  and  because, 

23 


THE  BANKING  AND  CURRENCY  PROBLEM 

by  Act  of  Congress,  it  is  made  the  duty  of  the 
Secretary  of  the  Treasury  to  maintain  these  silver 
dollars  at  a  parity  with  gold. 

At  the  present  day  few  persons  would  be  so  un- 
wise as  to  favor  an  increase  of  the  issue  of  silver 
dollars,  which  are  declared  to  be  legal-tender 
money,  though  intrinsically  worth  only  about  fifty 
cents  in  gold.  People  have  not  yet  forgotten  that, 
not  many  years  ago,  the  continued  coinage  of  these 
silver  dollars  cost  the  country  hundreds  of  millions 
of  dollars,  and  by  causing  doubts  as  to  the  stability 
of  the  gold  standard  of  value  precipitated  a  great 
financial  panic.  It  will  be  pointed  out  hereafter 
that  the  issue  of  additional  Government  notes 
would  be  equally  dangerous  and  unwise,  even 
though  the  Government  should  undertake  to 
maintain  a  large  gold  reserve  for  their  redemp- 
tion. 

If,  then,  the  issue  of  more  legal-tender  silver 
dollars  and  Government  notes  be  excluded,  the 
only  way  of  increasing  the  aggregate  amount  of 
money  in  the  United  States  available  as  bank 
reserves  is  by  adding  to  the  stock  of  gold.  As  gold 
cannot  be  created  by  statute,  it  follows  that  the 
only  practicable  way  of  increasing  the  aggregate 
amount  of  money  available  as  true  bank  reserves 
is  by  obtaining  additional  gold  from  the  mines, 
or  by  importing  it  from  abroad,  either  by  means 

24 


IN  THE  UNITED  STATES 

of  foreign  loans  or  by  means  of  exports  of  cotton 
or  grain  or  other  property,  or  of  stocks  and  bonds. 


Maintenance  of  the  Gold  Standard  and  of  Cash  Payments 

There  is  a  radical  difference  between  the  main- 
tenance of  the  gold  standard  of  value  and  the 
maintenance  of  cash  payments  by  the  banks. 
Maintenance  of  the  gold  standard  of  value  means 
that  all  the  legal-tender  currency  other  than  gold — 
in  other  words,  the  Government  notes,  or  green- 
backs, and  the  silver  currency — shall  be  kept  at 
a  parity  with  gold,  so  that  any  one  having  Govern- 
ment notes  or  silver  dollars  and  desiring  gold,  can 
obtain  for  the  Government  notes  or  silver  dollars 
an  equal  sum  in  gold  dollars.  It  means  that  all 
paper  and  silver  currency,  which  debtors  are  re- 
quired by  law  to  accept  in  payment  of  their  claims, 
shall  be  maintained  at  a  value  equal  to  gold  coin, 
so  that  debts  cannot  be  paid  in  a  depreciated  cur- 
rency. On  the  other  hand,  maintenance  of  cash 
payments  by  the  banks  means  that  the  banks 
shall  continue  to  perform  their  contracts  to  pay 
their  depositors  and  note-holders  on  demand  in 
any  kind  of  currency  in  which  the  bank  deposits 
are  payable. 

If  there  were  no  Government  notes  and  no  silver 
in  our  currency — if  gold  were  the  only  legal-tender 

3  25 


THE  BANKING  AND  CURRENCY  PROBLEM 

money  of  the  United  States — no  question  ever 
could  arise  as  to  the  maintenance  of  the  gold  dollar 
as  the  standard  of  value.  A  default  on  the  part 
of  the  banks  to  pay  their  deposit  liabilities  on  de- 
mand would  not  in  the  least  affect  the  standard  of 
value.  Under  these  circumstances  the  deposit 
liabilities  of  the  banks  might  fall  in  value  and 
might  sell  at  a  discount,  but  the  standard  of  value 
would  remain  unchanged.  During  the  recent  panic, 
when  the  banks  suspended  payments,  gold  and 
other  lawful  money  at  one  time  was  quoted  at  a 
premium  of  three  per  cent. ;  but  of  course  this 
did  not  mean  really  that  gold  had  risen  to  a  pre- 
mium and  that  the  standard  of  value  had  changed. 
It  meant  that  the  obligation  of  the  banks  to  pay 
depositors  on  demand  (which  obligation  was  in 
default  and  could  not  be  collected  for  the  time 
being)  had  fallen  below  its  face  value.  It  meant 
that  a  check  on  a  bank  for  one  hundred  dollars 
was  worth  only  about  ninety-seven  dollars  in  actual 
cash,  because  cash  was  wanted  and  the  bank  could 
not,  or  would  not,  on  demand,  pay  the  check  in 
cash. 

The  issue  of  notes  by  the  banks  would  not  affect 
the  standard  of  value,  though  the  banks  should 
suspend  payment  and  the  notes  fall  to  a  discount, 
unless  the  bank-notes  were  made  a  legal  tender. 
A  person  entitled  to  a  sum  of  money  could  refuse 

26 


IN  THE  UNITED  STATES 

the  notes  and  could  insist  upon  payment  in  gold 
or  other  lawful  money,  or  he  could  accept  bank- 
notes at  their  current  depreciated  value.  Before 
the  war  many  issues  of  bank-notes  were  current 
at  various  rates  of  discount,  but  nevertheless  the 
gold  standard  of  value  remained  unchanged. 


Issue  of  Bank-Notes 

While  there  is  no  practicable  way  of  increasing 
the  aggregate  amount  of  lawful  money  in  the 
country  except  by  digging  gold  out  of  the  ground 
or  by  importing  it  from  abroad,  there  is  a  way  of 
rendering  available  as  bank  reserves  part  of  the 
gold  and  other  lawful  money  already  in  circulation 
among  the  people.  This  result  can  be  brought 
about  through  the  issue  of  bank-notes,  which  are 
merely  promissory  notes  of  the  banks  to  pay  law- 
ful money  to  bearer  on  demand. 

If  the  public  have  entire  confidence  that  when- 
ever these  notes  are  presented  for  payment  lawful 
money  can  be  obtained  in  exchange,  people  will 
accept  the  notes  as  equivalent  to  lawful  money  and 
the  notes  will  serve  as  a  circulating  medium  in 
place  of  lawful  money.  The  lawful  money  in  place 
of  which  the  bank-notes  are  used  as  a  circulating 
medium  thereby  is  made  available  as  a  reserve  for 
the  banks,    Though  the  aggregate  amount  of  law- 

27 


THE  BANKING  AND  CURRENCY  PROBLEM 

ful  money  good  as  bank  reserves  cannot  be  in- 
creased by  an  issue  of  bank-notes,  the  portion  of  the 
existing  lawful  money  available  as  bank  reserves 
may  be  increased  by  substituting  bank-notes  for 
lawful  money  in  circulation. 


Effects  of  Issuing  Bank-Notes 

When  the  deposit  liabilities  and  loans  of  the  banks 
already  are  expanded  to  the  limit  of  safety,  having 
regard  to  their  reserves,  a  withdrawal  of  lawful 
money  from  the  reserves  may  cause  an  enormous 
shrinkage  of  the  credit  power  of  the  banks.  On 
the  basis  of  the  average  expansion  of  bank  credits 
in  relation  to  reserves,  the  withdrawal  of  $ioo,- 
000,000  of  reserve  money  may  involve  a  shrinkage 
of  more  than  $500,000,000  in  the  credit  power  of 
the  National  banks  alone,  and  a  shrinkage  of  more 
than  $1,000,000,000  in  the  collective  credit  power 
of  all  the  banks  and  trust  companies.  If,  how- 
ever, when  an  unusual  amount  of  currency  is  de- 
manded by  the  public  for  use  as  a  circulating 
medium,  the  banks  could  issue  notes  instead  of  pay- 
ing out  lawful  money  from  their  reserves,  they  could 
by  this  means  prevent  the  depletion  of  their  reserves 
and  could  avoid  the  necessity  of  reducing  largely 
their  loans  and  discounts  and  their  deposit  liabili- 
ties.    Therefore,  the  issue  of  bank-notes  is  a  potent 

28 


IN   THE   UNITED  STATES 

means  of  preventing  a  reduction  of  reserves  and  a 
contraction  of  the  credit  power  of  the  banks  when  an 
unusual  amount  of  currency  is  needed  for  circulation. 
The  issue  of  bank-notes  is  available,  not  only  as 
a  means  of  preventing  a  reduction  of  the  reserves 
of  the  banks  and  the  consequent  large  contraction 
of  their  credit  power,  but  also  as  a  means  of  in- 
creasing bank  reserves,  and  of  causing  a  large  ex- 
pansion of  the  power  of  the  banks  to  grant  credits. 
If,  when  there  is  no  demand  for  an  unusual  amount 
of  circulating  currency,  bank-notes  could  be  issued 
and  kept  in  circulation  in  substitution  for  lawful 
money,  the  lawful  money  displaced  by  the  notes 
would  accumulate  in  the  banks,  thereby  increasing 
their  reserves  and  causing  a  large  increase  of  their 
power  to  grant  credits.  If  $100,000,000  of  bank- 
notes could  be  put  out  and  kept  in  circulation  in 
place  of  a  like  amount  of  lawful  money,  this  law- 
ful money  would  be  added  to  the  bank  reserves  and 
the  credit  power  of  the  banks  would  be  increased 
more  than  $500,000,000,  according  to  the  present 
average  expansion  of  credits  of  the  National 
banks,  and  more  than  $1,000,000,000,  according 
to  the  present  average  of  all  the  banks  and  trust 
companies.  In  the  case  of  State  banks  and  trust 
companies  which  are  permitted  to  hold  National 
bank-notes  as  reserves,  it  would  not  be  necessary 
even  to  go  through  this  process  of  substituting  the 

29 


THE  BANKING  AND  CURRENCY  PROBLEM 

bank-notes  for  lawful  money  in  circulation.  The 
notes  would  be  an  addition  to  the  amount  of  cur- 
rency in  the  country  directly  available  as  reserves 
for  these  State  banks  and  trust  companies. 

In  order  to  serve  their  purpose,  bank-notes  must 
be  kept  at  a  parity  with  gold  and  other  lawful 
money.  As  long  as  this  parity  continues,  it  is 
immaterial  to  the  people  at  large  whether  they  re- 
ceive lawful  money  or  bank-notes,  and  rarely,  if 
ever,  do  the  public  present  bank-notes  for  redemp- 
tion in  lawful  money.  The  National  banks,  how- 
ever, always  prefer  lawful  money,  because  lawful 
money  is  good  as  a  reserve,  whereas  bank-notes  are 
not  good  for  that  purpose.  For  that  reason  the 
National  banks,  whenever  practicable,  keep  law- 
ful money  and  pay  out  their  own  notes,  or  the 
notes  of  other  banks. 

When  the  people  have  in  their  possession  more 
currency  than  they  need,  they  deposit  the  excess 
in  the  banks,  without  discriminating  between  lawful 
money  and  bank-notes,  which  to  them  are  of  equal 
value.  The  National  banks,  however,  assort  this 
currency  and,  whenever  practicable,  keep  the  re- 
serve money,  while  paying  out  notes  to  depositors 
who  call  for  currency.  A  constant  process  of  sift- 
ing the  currency  thus  goes  on — the  lawful  reserve 
money  being  accumulated  by  the  banks  which 
put  the  notes  in  circulation  in  place  of  reserve 

30 


IN  THE  UNITED  STATES 

money.  When  there  is  a  demand  for  an  unusual 
amount  of  currency  for  use  as  a  circulating  medium, 
the  banks,  if  they  have  power  to  issue  notes,  pay 
out  notes  to  meet  this  increased  demand.  When 
the  additional  currency  thus  created  is  no  longer 
needed,  people  do  not  pick  out  the  bank-notes  and 
return  them  to  the  banks  and  keep  the  reserve 
money  in  circulation,  but,  to  the  extent  of  the 
excess  of  currency  in  circulation,  the  reserve  money 
and  the  bank-notes  are  deposited  indiscriminately. 
The  banks  again  sift  the  currency  so  deposited  and 
retain  the  reserve  money,  but  when  currency  is 
demanded  for  use  as  a  circulating  medium  they 
again  pay  out  notes. 

This  process  of  substituting  bank-notes  for  law- 
ful reserve  money  in  circulation  goes  on  continually, 
and  is  bound  to  go  on  so  long  as  the  National  banks 
prefer  to  pay  out  bank-notes  rather  than  reserve 
money,  and  the  public  are  indifferent  whether  they 
receive  notes  or  reserve  money.  Through  this 
process  about  six  hundred  million  dollars  of  Na- 
tional bank-notes  are  kept  outstanding  year  in, 
year  out,  even  when  the  aggregate  amount  of  the 
currency  is  unnecessarily  large  and  when  interest 
rates  have  fallen  to  a  minimum.  It  is  through  this 
process  that  practically  all  the  gold  in  Canada  has 
been  accumulated  in  the  banks,  while  the  currency 
in  circulation  among  the  people  consists  almost 

31 


THE  BANKING  AND  CURRENCY  PROBLEM 

entirely  of  bank-notes,  subsidiary  silver,  and  small 
Government  notes. 

Facility  of  redemption  of  bank-notes  would  not 
prevent  this  process  of  substituting  bank-notes  for 
lawful  reserve  money  in  circulation,  because  as  long 
as  bank-notes  are  worth  as  much  as  other  currency 
the  public  do  not  present  notes  for  redemption ;  and 
when  a  bank  presents  notes  to  another  bank  for  re- 
demption this  operates  merely  as  a  transfer  of  re- 
serve money  from  one  bank  to  another  bank.  No 
doubt  if  bank-notes  could  be  redeemed  in  lawful 
money,  promptly,  and  without  expense  to  the  holder, 
each  National  bank  receiving  notes  of  other  banks 
would  present  them  for  redemption  instead  of  accu- 
mulating them  in  its  vaults.  But  this  would  not 
diminish  the  amount  of  notes  in  circulation  among 
the  people,  or  tend  to  check  the  gradual  substitution 
of  notes  for  lawful  money  in  circulation  as  long  as 
the  banks  can  issue  notes  and  lawful  money  re- 
mains in  circulation.  It  is  to  be  borne  in  mind, 
also,  that  State  banks  and  trust  companies  which, 
by  law,  can  hold  National  bank-notes  as  reserves 
would  have  no  incentive  to  present  the  bank-notes 
for  redemption  in  lawful  money. 

Difference  between  Notes  and  Other  Instruments 

In  recent  discussions  it  has  been  urged  by  high 
authority  that,  as  a  bank-note  represents  merely 

32 


IN  THE  UNITED  STATES 

a  liability  of  the  issuing  bank  to  pay  on  demand 
a  specified  sum,  an  issue  of  bank-notes  has  the 
same  effect  as  the  creation  of  a  like  amount  of 
deposit  liabilities,  or  the  issue  of  cashier's  checks 
or  certificates  of  deposit;  and  that  undue  expan- 
sion of  bank  credits  through  the  issue  of  bank- 
notes can  be  prevented  by  requiring  the  banks 
to  keep  against  their  outstanding  notes  the  same 
reserves  as  against  their  deposit  liabilities.  This 
appears  to  be  a  dangerous  error.  By  issuing 
circulating  notes  the  banks,  indirectly,  may  in- 
crease their  reserves  of  lawful  money  and  their 
credit  power  in  a  way  that  is  not  possible  by  means 
of  cashier's  checks  or  certificates  of  deposit,  or  by 
means  of  checks  drawn  upon  the  banks  by  de- 
positors. It  is  true  that  the  liability  of  a  bank  to 
pay  its  notes  on  demand  is  essentially  the  same  as 
its  liability  to  pay  its  cashier's  checks  or  certificates 
of  deposit,  or  its  liability  to  pay  checks  of  its  de- 
positors; but  bank-notes  are  a  practical  substitute 
for  lawful  money  as  a  circulating  medium,  whereas 
certificates  of  deposit,  cashier's  checks,  and  checks 
drawn  by  bank  depositors  are  not  available  for 
that  purpose,  except  to  a  limited  extent.  Theo- 
retically, it  might  be  possible  to  dispense  with  the 
use  of  our  present  currency  as  a  circulating  medium 
and  to  use  only  cashier's  checks,  certificates  of  de- 
posit, or  checks  drawn  by  bank  depositors;    but 

23 


THE  BANKING  AND  CURRENCY  PROBLEM 

we  know  that  the  people  of  the  United  States  al- 
ways require  the  use  of  more  than  fifteen  hundred 
million  dollars  of  gold,  silver,  greenbacks,  or  bank- 
notes, and  that  neither  checks  nor  certificates  of 
deposit  are  a  practical  substitute  for  this  currency 
required  by  the  people.  In  practice  it  is  not  pos- 
sible for  the  banks  to  prevent  a  depletion  of  their 
reserves  and  a  resulting  money  stringency  by  offer- 
ing to  issue  cashier's  checks  or  certificates  of  de- 
posit in  lieu  of  paying  out  currency  when  currency 
is  demanded.  For  the  same  reason  cashier's  checks, 
certificates  of  deposit,  and  checks  drawn  by  bank 
depositors  cannot  drive  lawful  money  out  of  cir- 
culation into  the  National  bank  reserves.  By 
issuing  circulating  notes  to  take  the  place  of  lawful 
money  in  circulation  the  banks  may  cause  an  in- 
crease of  their  reserves  and  a  large  expansion  of 
their  power  to  grant  credits,  but  no  such  conse- 
quences can  result  from  the  issue  of  cashier's  checks 
or  certificates  of  deposit,  or  by  the  creation  of  de- 
posit liabilities,  for  these  are  not  practical  sub- 
stitutes for  lawful  money  as  a  circulating  medium. 

Regulation  of  the  Banks 

In  the  main,  the  banks  in  the  United  States  have 
been  managed  honestly  and  with  signal  ability, 
and  they  have  served  the  country  well.  The  ulti- 
mate losses  of  depositors  in  the  banks  and  the  trust 

34 


IN  THE  UNITED  STATES 

companies  have  been  remarkably  small,  having 
regard  to  the  fact  that  there  are  approximately 
twenty  thousand  banks  and  trust  companies  doing 
a  banking  business,  and  that  many  of  them  were 
established  in  newly  developed  sections  of  the 
country  by  men  who  had  little  or  no  previous 
experience  as  bankers. 

The  main  causes  of  failures  of  individual  banks 
are  dishonesty,  bad  business  judgment,  and  over- 
expansion  of  liabilities  in  relation  to  reserves. 
Dishonesty  and  bad  business  judgment  never  can 
be  wholly  prevented  by  statute.  No  legislation  can 
make  bank  managers  honest  and  wise,  or  prevent 
occasional  bank  failures  resulting  from  dishonest 
or  foolish  management.  Sound  judgment  and  a 
large  measure  of  discretion  are  essential  to  the  suc- 
cessful management  of  the  banking  business,  and 
any  attempt,  by  statutory  rules  and  regulations, 
to  prevent  bank  managers  from  committing  errors 
of  judgment  or  abuses  of  discretionary  powers  is 
bound  to  prove  a  failure. 

However,  there  are  practices  that  ought  to  be 
prohibited  by  law  because  they  tend  to  errors  of 
judgment  or  to  actual  fraud.  Thus  the  laws  should 
prohibit  the  managing  officers  of  a  bank  from  bor- 
rowing from  their  bank  or  from  dealing  with  it, 
directly  or  indirectly,  for  their  own  benefit;  and 
also  should  prohibit  dealings  between  a  bank  and 

35 


THE  BANKING  AND  CURRENCY  PROBLEM 

a  company  in  which  its  managing  officers  are  per- 
sonally interested.  Furthermore,  the  best  prac- 
ticable provision  should  be  made  for  the  prompt 
discovery  and  prevention  of  dishonest  or  unsound 
banking  methods.  The  examinations  of  the  banks 
by  the  Comptroller  should  be  made  more  thorough, 
and  statutory  authority  should  be  given  to  the 
clearing-house  associations  in  the  various  cities  to 
examine  the  affairs  of  their  members  and  to  ex- 
ercise a  large  measure  of  supervision,  including 
power  to  stop  any  course  of  business  that  is  im- 
prudent even  if  lawful. 


Inswfficient  Reserves  and  Over-Expansion  of  Credits 

The  question  of  the  sufficiency  of  bank  reserves, 
or,  in  other  words,  how  far  the  banks  can  safely 
expand  their  liabilities  in  relation  to  reserves,  must 
be  considered  in  two  aspects.  It  must  be  con- 
sidered with  regard  to  the  position  of  each  bank 
severally,  and  it  must  be  considered  also  with  re- 
gard to  the  position  of  all  the  banks  collectively 
and  to  the  entire  credit  situation. 

The  sufficiency  of  the  reserves  of  any  particular 
bank,  considered  without  regard  to  the  entire  credit 
situation,  depends  largely  upon  the  character  of 
the  deposit  liabilities  and  assets  of  the  bank.  Thus, 
as  a  rule,  safety  would  require  a  bank  to  keep  on 

36 


IN  THE  UNITED  STATES 

hand  against  very  large  deposits  of  single  depositors 
a  larger  percentage  of  reserve  than  against  an  equal 
aggregate  of  small  deposits  of  many  depositors, 
for  the  danger  that  the  reserves  of  a  bank  may 
be  exhausted  by  the  withdrawal  of  a  few  large 
deposits  is  greater  than  that  of  exhaustion  by 
the  withdrawal  of  a  large  number  of  small 
deposits.  Again,  safety  would  require  reserves 
against  deposits  that  fluctuate  widely  in  amount, 
or  that  are  known  to  be  only  temporary,  to  be 
larger  than  those  against  deposits  of  a  more  per- 
manent character.  For  this  reason  reserves  against 
deposits  of  other  banks  and  against  deposits  of 
stock-brokers,  or  others  engaged  in  a  fluctuating 
or  uncertain  business,  should  be  larger  than  those 
against  savings  deposits  or  against  ordinary  mer- 
cantile deposits.  Again,  the  character  of  a  bank's 
loans  and  investments  has  an  important  bearing 
upon  the  sufficiency  of  its  reserves,  considered  with- 
out regard  to  the  credit  situation  as  an  entirety. 
Thus,  under  normal  financial  conditions,  a  bank 
whose  bills  receivable  consist  largely  of  good  call 
loans  convertible  promptly  into  cash,  or  of  good 
short-time  commercial  paper  maturing  from  day 
to  day,  would  be  safe  with  a  smaller  amount  of 
cash  in  its  vaults  than  a  bank  whose  assets  consist 
largely  of  time  loans  or  other  investments  that  can- 
not be  converted  promptly  into  cash. 

37 


THE  BANKING  AND  CURRENCY  PROBLEM 

It  follows  that  the  question  how  far  any  par- 
ticular bank  may  safely  expand  its  liabilities  in 
relation  to  reserves  is  a  question  of  sound  business 
judgment,  and  can  be  determined  only  by  those 
familiar  with  the  entire  business  of  the  bank  and 
with  the  character  of  its  deposits  and  of  its  assets. 
For  this  reason  it  has  not  been  found  advisable 
in  foreign  countries  to  prescribe,  by  statute, 
the  minimum  reserves  which  each  individual 
bank  shall  keep  in  relation  to  its  deposit  liabil- 
ities. 


Minimum  Reserves  of  National  Banks 

The  statutory  minimum  reserves  of  the  National 
banks  vary  according  to  location.  National  banks 
in  central  reserve  cities — i.e.,  New  York,  Chicago, 
and  St  Louis — are  required  to  keep  in  their  vaults 
an  amount  of  lawful  money  equal  to  25  per  cent. 
of  their  deposit  Habilities.  Banks  in  reserve  cities 
are  required  to  keep  reserves  nominally  equal  to 
25  per  cent,  of  their  deposit  liabilities,  but  of  these 
reserves  only  one-half  need  be  in  lawful  money, 
and  the  other  half  may  be  in  the  form  of  deposits 
with  banks  in  central  reserve  cities.  Country  banks 
are  required  nominally  to  keep  reserves  equal  to 
15  per  cent,  of  their  deposits,  but  of  these  reserves 
three-fifths  may  be  in  the  form  of  deposits  with 

38 


IN  THE  UNITED  STATES 

banks  in  reserve  cities  or  central  reserve  cities  and 
only  two-fifths  need  be  lawful  money. 

This  classification  appears  to  be  based  upon  no 
sound  principle  and,  from  every  point  of  view,  to 
be  arbitrary.  If  the  object  of  requiring  the  banks 
to  keep  minimum  reserves  is  to  provide  for  the 
safety  of  the  entire  credit  situation,  no  deposits 
of  banks  with  other  banks  should  be  counted  as 
reserves.  Deposits  of  one  bank  with  another  bank 
do  not  augment  the  total  reserves  of  the  banks 
available  for  the  payment  of  all  their  deposit  lia- 
bilities, and  do  not  in  the  least  strengthen  the  gen- 
eral credit  situation.  Such  deposits  merely  enable 
some  banks  to  strengthen  their  reserves  by  ex- 
hausting pro  tanto  the  reserves  of  other  banks.  If, 
however,  the  object  is  to  provide  for  the  safety  of 
the  several  banks  considered  individually,  without 
regard  to  the  general  credit  situation,  then  no  test 
is  furnished  by  the  location  of  the  several  banks, 
whether  in  a  central  reserve  city,  or  in  a  reserve 
city,  or  elsewhere.  The  ability  of  a  bank  to  pay 
its  depositors,  on  demand,  in  cash,  depends,  not 
upon  the  location  of  the  bank,  but  upon  the  nature 
of  its  assets  and  of  its  deposit  liabilities.  Again, 
if  the  object  is  to  provide  for  the  ultimate  security 
of  bank  depositors,  and  not  merely  for  the  ability 
of  the  banks  on  demand  to  pay  cash,  then  the  test 
of  safety  would  be  a  comparison  of  the  amount  of 

39 


THE  BANKING  AND  CURRENCY  PROBLEM 

the  capital  and  surplus  of  the  bank  with  its  lia- 
bilities, because  the  capital  and  surplus  of  a  bank 
is  the  only  margin  of  security  for  the  ultimate  pay- 
ment of  its  liabilities. 

The  framers  of  the  National  Banking  Act  re- 
quired the  reserve  city  banks  to  carry  cash  reserves 
larger  than  those  of  the  country  banks,  probably, 
because  it  was  contemplated  that  the  country 
banks  would  keep  part  of  their  reserves  in  the  form 
of  deposits  with  the  reserve  city  banks,  and  that 
the  reserves  of  the  latter  thus  would  serve  as  re- 
serves not  only  for  their  own  deposit  liabilities, 
but  also  in  part  for  those  of  the  country  banks. 
The  banks  in  the  central  reserve  cities  were  re- 
quired to  keep  their  25  per  cent,  reserves  wholly  in 
cash,  probably,  because  it  was  contemplated  that 
the  reserve  city  banks  would  keep  half  of  their 
minimum  reserves  in  the  form  of  deposits  with 
central  reserve  city  banks,  and  that  the  reserves 
of  the  latter  thus  would  constitute,  in  part,  ulti- 
mate reserves  for  all  the  banks.  It  is  obvious, 
however,  that  if  a  bank  in  a  reserve  city,  or  in  a 
central  reserve  city,  does  not  owe  deposits  to  other 
banks,  and  if  its  deposits  consist  principally  of 
steady  commercial  deposits,  safety  would  not  re- 
quire it  to  keep  as  high  a  percentage  of  reserve  as 
a  bank  that  owes  deposits  to  other  banks.  For 
the  purpose  of  ascertaining  the  collective  condi- 

40 


IN   THE  UNITED  STATES 

tion  of  the  banks  and  the  general  credit  situation, 
the  system  established  by  the  National  Banking 
Act,  and  the  reports  of  the  Comptroller  under  this 
Act,  at  best,  are  misleading,  because  part  of  the 
reserve  money  held  by  the  banks  is  counted  twice, 
and  some  of  it  three  times. 

Therefore,  it  is  desirable  to  reconsider  and  revise 
the  provisions  of  the  National  Banking  Act,  pre- 
scribing the  minimum  reserves  to  be  kept  by  the 
various  banks.  Having  regard  to  the  general  bank- 
ing situation,  deposits  of  one  bank  in  another  bank 
should  not  be  counted  as  reserves.  Money  is  the 
only  ultimate  bank  reserve.  Having  regard  to  the 
safety  of  the  several  banks  considered  separately, 
the  minimum  reserves  of  the  banks  should  be  deter- 
mined, not  by  their  location,  but  by  the  character 
of  their  deposits  and  of  their  assets. 

A  sounder  plan  would  be  to  require  the  banks 
to  keep  against  deposits  of  other  banks  and  of  trust 
companies  minimum  reserves  higher  than  those 
against  ordinary  deposits  of  individuals,  and  to 
require  the  whole  of  the  minimum  reserves  to  be 
kept  in  lawful  money  in  the  banks.  For  example, 
it  might  be  provided  that  all  National  banks  shall 
maintain  lawful  money  reserves  amounting  to  30 
per  cent,  of  such  of  their  deposits  as  may  be  owing 
to  other  National  banks,  State  banks,  trust  com- 
panies, and  private  bankers,  and  10  per  cent,  of 
4  41 


THE  BANKING  AND  CURRENCY  PROBLEM 

all  other  deposits,  with  power  in  each  clearing- 
house association,  upon  obtaining  the  approval  of 
the  Comptroller  of  the  Currency,  to  increase  the 
latter  percentage,  temporarily,  as  to  all  or  any 
banks  that  are  members  of  the  clearing-house 
association.  It  might  be  provided,  also,  that  no 
bank  may  incur  deposit  lial^ilities  to  an  amount  in 
the  aggregate  exceeding  five  times  the  amount  of 
its  capital  and  surplus.  The  foregoing  percent- 
ages are  indicated,  not  for  adoption,  but  merely 
for  the  purpose  of  showing  how  the  reserve  require- 
ments of  the  banks  could  be  placed  upon  a  sounder 
basis. 

Necessarily,  any  statutory  rule  must  be  arbitrary, 
for  the  extent  to  which  a  bank  can  safely  expand 
its  liabilities  depends  largely  upon  the  character  of 
its  loans  and  other  assets,  and  upon  its  entire  busi- 
ness. Unfortunately,  in  the  United  States  an  im- 
pression has  grown  up  that  because  certain  mini- 
mum reserves  are  prescribed  by  law  any  bank  safely 
may  make  loans  (especially  call  loans)  and  may 
create  deposit  liabilities  to  any  extent  found  prof- 
itable, if  only  the  minimum  reserves  prescribed  by 
law  be  maintained.  If  this  impression  had  not 
grown  up  in  the  United  States,  and  if  our  bankers, 
to  the  same  extent  as  bankers  in  Europe,  were 
governed  by  conservative  traditions,  there  would 
be   strong   arguments   in    favor   of   adopting   the 

42 


IN  THE  UNITED  STATES 

foreign  plan  to  fix  no  minimum  reserves  by  statute, 
but  to  allow  the  managers  of  each  bank,  from  time 
to  time,  to  determine  what  reserve  the  bank  shall 
keep.  However,  under  existing  conditions,  prob- 
ably it  would  be  unwise  to  adopt  the  foreign  plan 
and  to  abolish  all  statutory  reserve  requirements. 


Over-Expansion    with    Regard    to    the    General    Credit 
Situation 

The  managers  of  each  bank  have  the  power  to 
regulate  the  amount  of  its  loans  and  discounts  and 
the  expansion  of  its  deposit  liabilities  in  relation  to 
reserves,  having  regard  to  the  condition  of  the  par- 
ticular bank  which  they  control ;  but  in  the  United 
States  bank  managers  have  no  power  to  regulate 
the  expansion  of  credits  of  all  the  banks  with  a  view 
to  the  security  of  the  general  credit  situation,  and 
have  no  power,  through  the  issue  and  redemption 
of  bank-notes,  to  prevent  sudden  and  wide  fluctua- 
tions of  the  credit  power  of  the  banks  resulting  from 
the  fluctuations  of  the  volume  of  currency  used  as  a 
circulating  medium.  Though  the  managers  of 
fifty,  or  of  a  hundred,  out  of  the  seven  thousand 
National  banks  may  be  of  the  opinion  that,  having 
regard  to  existing  or  prospective  conditions,  the  ex- 
pansion of  credits  has  gone  too  far,  they  have  no 
power  to  accomplish  any  substantial  result.     They 

43 


THE  BANKING  AND  CURRENCY  PROBLEM 

could  restrict  the  grant  of  credits  by  their  own  banks 
and  so  lose  profitable  business  that  would  go  to 
other  banks,  but  they  could  not  materially  improve 
the  general  situation.  This  was  the  case  prior  to 
the  recent  panic.  For  months  before  the  panic 
many  intelligent  managers  of  banks  and  trust  com- 
panies knew  that  the  credit  situation  throughout 
the  country  had  become  strained,  and  accordingly, 
by  restricting  credits  and  by  making  call  loans  in- 
stead of  time  loans,  many  of  them  endeavored  to 
strengthen  their  own  institutions,  but  they  could 
do  little  for  the  protection  of  the  general  credit 
situation. 

The  main  problem  of  the  National  Monetary  Com- 
mission is  to  devise  an  adequate  means  of  regulat- 
ing and  of  protecting  the  general  credit  situation, 
so  as  to  avoid  sudden  and  wide  fluctuations  in  the 
amount  of  credit  available  for  the  transaction  of  the 
business  of  the  country.  The  regulation  of  the 
banks,  severally,  with  a  view  to  the  prevention  of 
dishonesty  and  unsound  banking  practices,  and  the 
regulation  of  reserves  with  regard  to  the  condition 
of  the  several  banks  considered  separately,  are 
matters  of  minor  importance.  The  reserves  and 
the  expansion  of  credits  of  each  separate  bank  can 
be  regulated  intelligently  only  by  the  officers  of  the 
bank  conversant  with  its  condition  and  the  charac- 
ter of  its  business.     Even  if  sc^me  of  the  banks  oc- 

44 


IN  THE  UNITED  STATES 

casionally  should  expand  ther  liabilities  too  far  in 
relation  to  their  reserves,  no  great  harm  would 
result  if  the  banks  throughout  the  country,  con- 
sidered collectively,  have  not  over-expanded.  If 
bank  credits  generally  have  not  been  over-expanded, 
as  was  the  case  during  the  recent  panic,  when  all 
the  banks  had  to  suspend,  any  individual  bank  that 
has  a  sufficient  amount  of  good  bank  assets  usually 
can  replenish  its  reserves  and  relieve  its  difficulties 
by  selling  part  of  its  assets,  or  by  borrowing  from 
other  banks. 


Central  Regulation  Necessary 

The  point  to  which  bank  credits  throughout  the 
country  may  be  expanded  with  safety  depends  upon 
many  circumstances  and  varies  from  time  to  time. 
A  ratio  of  reserves  to  liabilities  may  be  perfectly 
safe  under  certain  conditions  and  quite  unsafe 
under  other  conditions.  It  is  a  fatal  mistake  to 
assume  that  bank  credits  always  can  be  expanded 
with  safety  to  the  maximum  allowed  by  the  reserve 
requirements  of  the  National  Bank  Act.  Recent 
experience  has  shown  that  though  the  minimum 
reserves  required  under  the  National  Bank  Act  are 
sufficient  in  ordinary  times,  they  are  not  sufficient 
at  all  times,  and  that  credits  may  be  expanded 
beyond  the  limit  of  safety  although  the  legal  ratio 

45 


THE  BANKING  AND  CURRENCY  PROBLEM 

of  reserves  to  liabilities  be  maintained.  It  is  not 
sufficient  to  consider  merely  the  rate  of  interest  in 
Wall  Street.  It  is  not  sufficient  to  consider  the 
rate  of  interest  and  financial  conditions  throughout 
the  United  States.  It  is  necessary  to  consider  the 
whole  world.  The  financial  and  commercial  rela- 
tions between  the  leading  countries  of  the  world 
are  so  close  that  any  shock  affecting  financial  condi- 
tions in  one  country  would  be  felt  by  them  all, 
A  great  war,  or  a  financial  crash  in  any  country, 
would  affect  financial  conditions  throughout  the 
w'hole  civilized  world. 

It  is  necessary  to  consider,  also,  the  prospective 
expansion  of  business  and  the  prospective  demand 
for  credits  and  for  currency  throughout  the  world. 
Furthermore,  allowance  must  be  made  for  events 
that  cannot  be  foreseen.  There  are  times  when 
exceptional  conditions  render  necessary  an  ex- 
ceptional expansion  of  bank  credits,  or  of  the  cur- 
rency, as  a  temporary  measure  of  relief,  as,  for  ex- 
ample, when  a  panic  is  threatened  by  reason  of  the 
sudden  withdrawal  of  currency  in  unusual  amounts 
to  be  hoarded  by  depositors  who  have  lost  con- 
fidence in  the  banks.  In  such  case,  however,  safety 
would  require  that,  as  soon  as  the  immediate  need 
of  the  extraordinary  expansion  shall  have  been 
removed,  bank  credits  and  the  currency  shall  again 
be  contracted  to  a  normal  limit. 

46 


IN  THE  UNITED  STATES 

The  currency  situation,  also,  is  a  condition  hav- 
ing an  important  bearing  upon  the  safety  of  further 
expansion  of  the  currency  by  the  issue  of  bank- 
notes, or  of  further  expansion  of  bank  credits  in 
relation  to  reserves.  If,  by  reason  of  great  activity 
in  business  or  other  cause,  an  unusual  amount  of 
currency  is  in  circulation,  the  ratio  of  reserves  to 
deposit  liabilities  may,  with  safety,  be  lower  than 
when  only  a  normal  amount  of  currency  is  in  circula- 
tion and  there  are  grounds  for  anticipating,  in  the 
near  future,  additional  withdrawals  of  currency  for 
use  as  a  circulating  medium.  Moreover,  a  ratio  of 
reserves  to  liabilities  that  would  be  safe  when  little 
or  no  bank-note  currency  is  in  circulation  may  be 
perilously  unsafe  when  a  large  part  of  the  currency 
in  circulation  consists  of  bank-notes,  because,  under 
such  conditions,  bank  credits  already  have  been 
expanded  by  the  substitution  of  notes  for  money 
as  a  circulating  medium. 

There  is  no  country  in  the  world  where  the  volume 
of  currency  in  circulation  and  the  demand  for  bank 
credits  fluctuate  more  widely  than  in  the  United 
States.  This  is  due  to  the  great  expanse  of  our 
territory,  to  the  annual  harvest  requirements  of  the 
agricultural  sections,  to  the  prevailing  business 
activity  and  enterprise,  and  to  the  rapid  and  un- 
equal increase  of  population  and  wealth  in  different 
sections.     Furthermore,  there  is  no  country  in  the 

47 


THE  BANKING  AND  CURRENCY  PROBLEM 

world  where  intelligent  control  over  bank  credits 
and  bank  reserves  is  needed  more  than  in  the 
United  States.  There  are  in  the  United  States 
nearly  seven  thousand  National  banks,  besides 
twice  as  many  State  banks  and  trust  companies. 
Each  of  these  institutions  acts  for  its  individual 
interest  alone,  independently  of  the  others,  and 
the  prevailing  tendency  of  each  at  all  times  is  to 
expand  its  credits  to  the  limit  permitted  by  law. 
The  country  banks  lend  their  surplus  resources  in 
the  form  of  deposits  at  interest  to  the  banks  in  the 
larger  cities,  and  the  banks  in  the  principal  money 
centres  commonly  expand  their  credits  as  much  as 
practicable  by  lending  on  call  such  sums  as  they 
deem  it  unsafe  to  lend  on  time  or  by  discount  of 
commercial  paper.  Each  bank  with  a  deposit  in 
another  bank  assumes  that,  in  case  of  need,  it  can 
strengthen  its  reserve  by  drawing  upon  this  de- 
posit; but  it  fails  to  consider  that,  when  thus  it 
strengthens  its  own  reserve,  it  must  to  the  same 
extent  weaken  the  reserve  of  the  other  bank,  and 
that  the  deposits  of  banks  with  other  banks  add  no 
strength  to  the  general  credit  situation.  Each 
bank  that  has  loaned  money  on  call  assumes  that, 
in  case  of  need,  it  can  strengthen  its  reserve  by 
calling  such  loans;  but  it  fails  to  consider  that, 
generally,  when  a  loan  is  called  the  borrower  is 
obliged  to  borrow  the  same  sum  from  some  other 

48 


IN  THE  UNITED  STATES 

bank,  although  a  high  rate  of  interest  may  be  ex- 
acted, and,  therefore,  that  call  loans  affect  the 
security  of  the  entire  bank  situation  practically  to 
the  same  extent  as  time  loans. 

In  the  United  States  there  is  no  way  of  regulat- 
ing the  supply  of  bank  credits  and  of  holding  part 
of  the  potential  supply  in  reserve  for  periods  of 
financial  stringency.  Consequently,  nearly  always 
there  is  either  an  over-abundance  of  money  (mean- 
ing credit  which  the  banks  are  ready  to  lend)  or  a 
money  famine.  It  has  been  argued  that  the  vol- 
ume of  credits  granted  by  the  banks  depends  upon 
business  activity  and  upon  the  consequent  demand 
for  credit  and  not  upon  the  power  of  the  banks  to 
grant  credits,  and,  therefore,  that  low  interest 
rates  have  little  effect  in  causing  an  expansion  of 
bank  credits.  Experience,  however,  shows  that  the 
contrary  is  the  case,  at  least  in  the  United  States. 
It  is  true  that,  when  there  is  loss  of  confidence  and 
when  business  is  depressed,  interest  rates  are  low, 
because  there  is  less  currency  in  circulation  and 
more  in  the  bank  reserves,  while  at  the  same  time 
the  demand  for  bank  credits  is  diminished.  It  is 
true,  also,  that  low  interest  rates  will  not  stimulate 
speculation  and  enterprise  unless  people  have  con- 
fidence and  are  ready  to  speculate  and  to  embark 
in  new  enterprises.  But  we  know  by  experience 
that  when  people  are  in  a  mood  for  speculation  and 

49 


THE  BANKING  AND  CURRENCY  PROBLEM 

for  business  expansion  low  interest  rates  operate 
as  a  powerful  stimulus  to  speculation  and  business 
expansion.  A  leading  banker  has  said:  "In  the 
long  run  commerce  suffers  more  from  the  periods  of 
over-abundance  (of  money)  than  from  those  of 
scarcity.  The  origin  of  each  recurring  period  of 
tight  money  can  be  traced  to  preceding  periods 
of  easy  money.  Whenever  money  becomes  so 
over-abundant  that  bankers,  in  order  to  keep  it 
earning  something,  have  to  force  it  out  at  abnor- 
mally low  rates  of  interest,  the  foundations  are 
laid  for  a  period  of  stringency  in  the  not  far  dis- 
tant future,  for  then  speculation  is  encouraged, 
prices  are  inflated,  and  all  sorts  of  securities  are 
floated  until  the  money-market  is  glutted  with 
them."* 


The  Central  Bank  Plan 

The  leading  nations  of  Europe  have  learned  by 
experience  that  no  rule  of  mechanical  application 
can  be  laid  down  and  no  automatic  system  can  be 
devised,  and  that  the  only  practicable  way  of  reg- 
ulating the  general  expansion  of  bank  credits  so 
as  to  provide  for  exceptional  conditions,  as  well  as 
for  the  ordinary  requirements  of  commerce,  is  to 

*  From  an  address  by  Mr.  James  B.  Forgan  to  the  Texas 
Bankers'  Association. 

SO 


IN  THE  UNITED  STATES 

invest  boards  of  experienced  men  with  some  meas- 
ure of  power  to  control  the  expansion  of  bank 
credits,  and  in  particular  with  the  power  to  regulate 
the  issue  of  bank-note  currency.  In  each  of  these 
countries  the  regulation  of  the  credit  situation  is 
effected  by  means  of  a  large  central  bank,  which, 
subject  to  Governmental  control,  is  considered 
charged  with  general  supervision  of  financial  condi- 
tions. The  systems  of  banking  and  currency  adopt- 
ed by  the  leading  commercial  nations  of  Europe 
differ  in  various  particulars,  but  all  have  in  common 
this  one  feature — a  large  central  bank  vested  with 
some  measure  of  power  to  control  the  general  ex- 
pansion of  bank  credits.  This  control  can  be  exer- 
cised by  the  central  bank  in  the  following  manner : 

(i)  By  acting  as  a  bank  for  the  discount  of  com- 
mercial paper,  and  by  raising  or  lowering  its  dis- 
count rate,  the  central  bank,  to  a  certain  extent, 
can  regulate  interest  rates  and  the  expansion  of 
credits  throughout  the  country  and  the  flow  of 
gold  to  or  from  the  country.  It  is  by  this  method 
that  the  Bank  of  England  regulates  the  credit 
situation  in  England. 

(2)  By  issuing  its  notes  the  central  bank  can 
prevent  a  withdrawal  of  bank  reserves  for  use  as 
circulating  currency  and  a  consequent  financial 
stringency,  and  by  diminishing  the  volume  of  its 
outstanding   notes   it    can    check   over-expansion 

51 


THE  BANKING  AND  CURRENCY  PROBLEM 

when  the  occasion  for  the  issue  of  the  notes  has 
passed.  The  central  banks  of  France  and  of  Ger- 
many regulate  financial  conditions  by  this  method 
as  well  as  by  changing  their  discount  rate. 


Central  Bank  Not  Practicable  in  the  United  States 

Many  able  bankers  are  of  the  opinion  that  in  the 
United  States  we  should  secure  the  necessary  cen- 
tral control  over  the  expansion  of  bank  credits, 
and  should  provide  for  the  stabiHty  of  financial 
conditions  by  adopting  the  European  plan — name- 
ly, by  establishing  a  great  central  bank. 

In  order  to  accomplish  the  desired  purpose  by 
means  of  a  central  bank,  it  would  be  necessary  to 
create  a  bank  of  colossal  magnitude  and  to  confer 
upon  it  a  monopoly  of  the  power  to  issue  bank-note 
currency.  The  eminent  Senators  and  Congressmen 
who  constitute  the  National  Monetary  Commission 
will  be  best  able  to  judge  whether  it  would  be  politi- 
cally practicable  to  secure  the  enactment  of  the  leg- 
islation necessary  to  establish  such  a  bank.  In  the 
opinion  of  the  writer  it  would  be  impossible.  Our  ex- 
perience with  the  former  Bank  of  the  United  States 
shows  that  the  people  of  the  United  States  would 
not  consent  to  the  creation  of  such  a  central  bank. 
The  people  could  not  be  convinced  that  it  would 
be  desirable,  or  that  it  would  be  safe  to  give  to  any 

52 


IN  THE  UNITED  STATES 

man  or  to  any  set  of  men  the  power  to  control  the 
vast  resources  of  such  a  bank,  and  to  dominate  all 
the  banks  and  business  interests  of  the  country. 

However,  even  if  it  were  practicable  to  obtain 
the  necessary  legislation,  it  would  not  be  desirable 
to  establish  such  a  great  central  bank.  The  prac- 
tical control  of  such  a  bank,  as  in  the  case  of  every 
successful  institution  of  that  kind,  would  soon  pass 
into  the  hands  of  one  man  or  of  a  very  small  num- 
ber of  men.  Although,  to-day,  the  best  man  or  set 
of  men  might  be  in  control,  there  would  always  be 
danger  that  the  control  might  pass  into  undesirable 
hands.  And  even  though  provision  could  be  made 
so  that  the  control  of  such  a  bank  always  would  re- 
main in  the  hands  of  the  wisest,  the  most  honor- 
able, and  the  most  disinterested  men,  it  would  not 
be  possible  to  satisfy  the  people  throughout  the 
country  that  the  vast  resources  and  powers  of  the 
bank  were  used  only  for  the  best  interests  of  all  the 
people  and  without  partiality  or  favor  to  any  sec- 
tion of  the  country,  or  to  any  class  or  set  of  people. 
The  administration  of  such  a  bank  would  be  a 
source  of  endless  sectional  differences  and  dissen- 
vsions,  and  soon  it  would  become  a  political  issue. 
The  South  would  want  the  bank,  by  means  of  loans, 
to  help  the  planters  to  accumulate  and  to  carry 
their  crops  of  cotton  and  tobacco  so  as  to  force 
higher  prices.     The  West  would  want  the  bank  to 

53 


THE  BANKING  AND  CURRENCY  PROBLEM 

use  its  resources  to  enable  the  farmers  to  raise  the 
price  of  corn  and  wheat.  The  large  money  centres 
would  want  the  bank  to  help  bankers  and  brokers 
to  carry  stocks  and  bonds  when  speculation  runs 
high  at  the  stock-exchanges.  Claims  would  be 
made  on  the  one  hand  that  the  bank  was  unduly 
favoring  the  country  banks,  and  on  the  other  hand 
that  it  was  unduly  favoring  the  banks  in  the  large 
cities.  In  every  period  of  financial  stringency  and 
of  high  interest  rates,  an  outcry  would  come  from 
every  part  of  the  country  that  the  central  bank 
should  relieve  the  situation ;  and  if  the  managers  of 
the  bank  should  deem  it  unsafe  to  yield  to  this 
outcry  by  expanding  credits  still  further,  their  re- 
fusal to  act  would  be  charged  to  selfish  motives,  or 
to  collusion  with  the  so-called  money  interests  of 
Wall  Street.  We  have  not  the  traditions  which  in 
foreign  countries  have  established  public  con- 
fidence in  the  management  of  their  great  central 
banks  and  have  made  them  useful  and  desirable 
institutions. 

A  great  central  bank  would  be  out  of  harmony 
with  our  business  habits  and  our  political  methods. 
Centralization  of  power  undoubtedly  furnishes  an 
effective  means  of  accomplishing  things  in  business 
as  well  as  in  politics.  Results  that  can  be  effected 
easily  by  an  autocrat  can  be  obtained  only  with 
difficulty  and  haltingly  by  individual  effort  and 

54 


IN  THE  UNITED  STATES 

under  a  system  of  popular  government.  But  if, 
in  order  to  preserve  our  institutions,  we  must  lose 
some  of  the  advantages  of  great  centralization  of 
power  in  business  as  well  as  in  matters  of  govern- 
ment, the  price  is  not  too  high. 

For  these  reasons  it  is  submitted  that  in  the 
United  States  the  central  bank  plan  is  not  prac- 
ticable or  desirable,  and  that  the  desired  central 
regulation  should  be  attained  by  other  methods. 


Independent  Bank-Note  Issues 

Divers  plans  have  been  proposed  for  the  regula- 
tion of  the  credit  situation  in  the  United  States  by 
the  issue  and  redemption  of  notes  of  the  various 
banks,  and  it  has  been  argued  that,  were  facilities 
adequate  for  the  speedy  redemption  of  the  notes, 
satisfactory  regulation  of  the  amount  of  the  cur- 
rency and  of  the  expansion  of  bank  credits  would 
result  automatically.  The  objection  to  these  plans 
is  that  they  furnish  facilities  for  expansion,  but  fail 
to  provide  against  over-expansion  and  furnish  no 
means  of  regulating  the  credit  situation. 

It  has  been  asserted  that  in  Canada  and  in  Scot- 
land the  power  to  issue  credit  currency  has  been 
given  to  the  several  banks  without  any  central 
control  and  that  in  those  countries  the  system  has 
worked  well.     In  all  Scotland  there  are  but  eight 

55 


THE  BANKING  AND  CURRENCY  PROBLEM 

banks,  each  having  numerous  branches,  and  their 
aggregate  note  issues  do  not  exceed  fifty  million 
dollars.  In  Canada  there  are  but  thirty-four  banks, 
each  also  having  numerous  branches,  and  their 
aggregate  note  issues  vary  from  seventy  to  a  hun- 
dred million  dollars.  Both  in  Scotland  and  in  Can- 
ada the  banks  act  in  harmony  in  carrying  out  an 
agreed  policy.  To  argue  that  because  this  system 
of  independent  bank-note  issues  works  satisfactorily 
in  small  and  conservative  Scotland,  with  its  eight 
banks  under  the  wing  of  the  great  central  Bank  of 
England,  and  in  Canada,  with  its  thirty-four  banks 
acting  in  concert,  therefore  the  same  system  would 
work  satisfactorily  in  a  country  as  large  as  the 
United  States,  with  twenty  thousand  independent 
banks  and  trust  companies,  including  seven  thou- 
sand National  banks  having  deposits  of  more  than 
five  thousand  million  dollars  and  already  having 
outstanding  bank-notes  amounting  to  about  six 
hundred  million  dollars,  exhibits  a  large  measure 
of  optimism  and  little  regard  for  the  judgment 
of  other  nations  and  for  the  lessons  of  our  own 
experience. 

The  great  commercial  nations  of  the  Old  World, 
England,  France,  and  Germany,  have  not  found  it 
safe  or  practicable  to  give  to  all  the  banks  the  power 
to  issue  circulating  notes  as  in  Scotland  and  in 
Canada.     Our   own   experience   indicates   the   re- 

56 


IN   THE   UNITED  STATES 

suit  that  would  follow  were  the  power  to  issue  ad- 
ditional notes  to  be  given  to  each  of  the  seven 
thousand  National  banks  in  the  United  States,  free 
from  central  control.  The  result  would  be  that, 
at  all  times,  each  bank,  without  regard  to  the 
general  credit  situation,  would  put  out  as  many- 
notes  as  practicable,  and  thus  there  would  be  in- 
jected into  the  currency  a  wholly  unelastic — that  is 
to  say,  non-contracting — issue  of  bank-notes.  This 
is  precisely  what  has  happened  in  consequence  of 
giving  to  the  banks  the  power  of  issuing  their  pres- 
ent bond-secured  notes.  These  notes  are  redeem- 
able at  the  will  of  any  holder  who  wants  to  redeem 
them,  but  by  experience  we  know  that  individuals 
do  not  present  bank-notes  for  redemption,  and  that 
the  banks  always  are  trying  to  keep  them  in  circula- 
tion. The  same  result  would  follow  if  the  banks 
were  authorized  to  issue  credit  notes,  or  any  other 
form  of  bank-note  currency  that  has  been  proposed, 
free  from  intelligent  central  control. 

As  has  been  pointed  out,  facilities  for  obtaining 
the  redemption  of  bank-notes  would  not  prevent  the 
substitution  of  notes  for  lawful  money  in  circulation, 
but  would  prevent  only  the  accumulation  of  notes 
in  the  vaults  of  the  National  banks.  The  amount 
of  notes  in  circulation  would  increase  as  long  as  the 
banks  could  issue  notes  and  as  long  as  there  was 
lawful  money  in  circulation  that  could  be  superseded 
s  57 


THE  BANKING  AND  CURRENCY  PROBLEM 

by  bank-notes  and  coliected  in  the  bank  reserves. 
The  desired  elasticity  of  the  currency  would  not 
be  brought  about  until  practically  all  the  lawful 
money  in  circulation  was  collected  in  the  banks, 
only  bank-notes  remaining  in  circulation.  This  is 
the  situation  in  Canada.  The  reason  why  the  note 
issues  of  the  Canadian  banks  contract  as  well  as 
expand  with  the  demand  for  circulating  currency 
is  that  practically  all  the  gold  has  been  driven  out 
of  circulation  into  the  banks,  while  only  bank-notes, 
subsidiary  silver  coin,  and  small  Government  notes 
are  used  as  circulating  currency. 


The  Cwrrency  Situation  in  the  United  States 

According  to  the  report  of  the  Comptroller  of  the 
Currency  for  1907,  the  aggregate  amount  of  gold 
coin  in  the  United  States  on  December  31,  1906, 
was  $1,593,300,000,  of  which  $1,081,500,000  was 
held  in  the  United  States  Treasury  (principally 
against  gold  certificates)  and  in  the  National  banks, 
and  $511,800,000  was  in  circulation.  In  the  re- 
vised estimate  of  the  director  of  the  mint,  on  August 
I,  1907,  the  estimates  previously  published  as  to 
the  amount  of  gold  coin  in  circulation  appear  to 
have  been  reduced  $135,000,000.  Of  necessity  any 
statement  as  to  the  amount  of  gold  actually  in 
circulation  must  be  a  mere  estimate  or  guess.     The 

58 


IN  THE  UNITED  STATES 

coin  in  circulation  cannot  be  counted,  and  the  re- 
ports of  the  mints  are  not  conclusive,  as  a  con- 
siderable amount  of  gold  coin  is  consumed  in  the 
arts  or  is  carried  out  of  the  country.  The  paper 
currency  and  silver  in  circulation  are  subject  also 
to  gradual  diminution  through  destruction  and 
loss;  but  not  much  silver  coin  is  consumed  in  the 
arts  or  carried  out  of  the  country,  as  the  bullion 
value  of  silver  dollars  is  only  about  one-half  their 
coin  value. 

The  annual  report  of  the  Comptroller  of  the 
Currency  contains  a  table  purporting  to  set  forth 
approximately,  as  of  December  31,  1906,  the  stocks 
of  gold,  silver,  and  uncovered  paper  currency,  and 
the  amounts  per  capita  in  the  principal  countries  of 
the  world.  The  method  of  determining  what 
portion  of  the  paper  currency  in  each  country  was 
uncovered  is  not  explained,  and  it  is  not  probable 
that  in  each  case  the  same  method  was  adopted. 
The  amount  of  gold  in  circulation  in  the  United 
States,  certainly,  was  largely  overestimated,  and 
the  amount  of  uncovered  paper  (being  the  National 
bank-notes  and  Government  notes,  less  the  coin 
reserved  for  their  payment,)  appears  to  have  been 
understated.  Nevertheless,  the  figures  furnished 
in  this  table  indicate: 

(i)  That  in  the  United  States  the  currency  con- 
tains a  smaller  percentage  of  gold  and  a  larger 

59 


THE  BANKING  AND  CURRENCY  PROBLEM 

percentage  of  silver  and  paper  than  the  currency  in 
the  United  Kingdom,  France,  and  Germany; 

(2)  That  in  the  United  States  the  volume  of  un- 
covered paper  currency  is  larger  in  proportion  to 
the  volume  of  gold  and  also  larger  per  capita  of 
population  than  in  any  of  those  countries ;  and 

(3)  That  in  the  United  States  the  percentage  of 
the  currency  that  does  not  consist  of  gold,  but 
is  declared  legal  tender  and  must  be  kept  at  a 
parity  with  gold,  is  larger  than  in  any  of  those 
countries. 

If  power  were  given  to  the  individual  banks  in 
the  United  States  to  issue  additional  bank-notes, 
free  from  central  control,  each  bank  would  issue  and 
keep  outstanding  as  many  as  practicable  of  these 
notes,  and,  for  the  reasons  given  in  the  preceding 
pages,  the  result  would  be  to  substitute  bank-notes 
for  legal  reserve  money  in  circulation  and  cor- 
respondingly to  increase  the  bank  reserves.  The 
increase  of  the  bank  reserves  effected  in  this  man- 
ner would  not  of  itself  be  harmful,  but  the  ultimate 
consequences  might  be  very  serious.  In  the  United 
States  there  are  twenty  thousand  banks  and  trust 
companies,  and  each  of  these  institutions,  acting 
in  its  own  interest  without  regard  to  the  general 
credit  situation,  habitually  makes  loans  and  dis- 
counts and  expands  deposit  liabilities  to  the  utmost 
practicable  extent  whenever  profitable.     Judging 

60 


IN  THE  UNITED  STATES 

by  past  experience,  if  through  an  issue  of  bank- 
notes the  bank  reserves  should  be  increased,  the 
banks  would  compete  in  expanding  credits  and 
in  increasing  loans  and  discounts  to  the  utmost 
practicable  extent,  thereby  causing  interest  rates 
to  become  excessively  low.  As  a  consequence,  gold 
would  be  exported  to  countries  where  interest  rates 
are  higher  and  where  the  gold  can  be  employed  more 
profitably,  while  in  the  United  States  speculation 
would  be  stimulated  and  bank  credits  would  be  ex- 
panded until  the  reserves  held  by  the  banks  and 
their  power  to  grant  credits  shall  have  adjusted 
themselves  according  to  the  demand  for  credits. 

It  may  be  urged  that  very  low  interest  rates 
(which,  however,  would  be  only  temporary)  and 
exports  of  unnecessary  gold  would  do  no  harm, 
and  that  it  is  sound  economy  to  carry  on  the  busi- 
ness of  the  country  with  as  little  gold  as  possible. 
It  may  be  profitable,  but  it  is  not  safe.  The 
United  States  is  the  richest  country  in  the  world, 
and  it  can  afford  to  use  in  its  currency,  relatively, 
as  much  gold  and  as  little  paper  and  silver  as  any 
other  country,  if,  by  so  doing,  it  will  increase  the 
safety  and  stability  of  the  general  financial  condi- 
tion. To-day,  in  the  United  States,  relatively  less 
gold  and  more  silver  and  paper  are  used  than  in 
any  of  the  other  great  commercial  countries,  al- 
though financial  conditions  are  far  less  stable  than 

6i 


THE  BANKING  AND  CURRENCY  PROBLEM 

in  those  countries.  It  would  not  be  prudent  still 
further  to  diminish  the  percentage  of  gold  in  our 
currency  in  order  to  save  the  use  of  a  compara- 
tively small  amount  of  gold  as  a  circulating  medium, 
for  this  could  be  done  only  by  substituting  silver 
or  notes  for  the  gold.  The  immediate  effect  would 
be  to  cause  an  inflation  of  bank  credits,  and  the 
ultimate  effect  would  be  to  render  less  secure  the 
maintenance  of  the  gold  standard  of  value  and  to 
weaken  the  foundation  of  the  whole  structure  of 
bank  credits  in  the  country. 


Regulation  by  Taxation 

Plans  also  have  been  proposed  to  regulate  the 
banking  and  currency  situation  by  authorizing 
the  National  banks,  in  case  of  emergency,  to  issue 
additional  notes  for  use  as  currency,  upon  pay- 
ment of  a  high  tax  imposed  to  prevent  the  banks 
from  issuing  the  additional  notes  except  during  a 
period  of  severe  money  stringency.  These  plans 
are  supposed  to  follow  a  German  precedent  which 
has  worked  with  marked  success,  the  Imperial  Bank 
of  Germany  being  allowed  to  issue  its  notes  in  ex- 
cess of  a  prescribed  limit,  only  upon  payment  of  a 
tax  at  the  rate  of  5  per  cent,  per  annum. 

That  these  plans  follow  the  German  precedent 
is  an  error.     If  the  German  system  were  adopted, 

62 


IN  THE   UNITED  STATES 

no  doubt,  we  should  have  sounder  financial  con- 
ditions in  the  United  States  than  exist  to-day;  but 
the  merit  of  the  German  system  does  not  lie  in 
the  imposition  of  a  5-per-cent.  tax  on  outstanding 
bank-notes.  It  lies  in  the  adherence  to  sound 
banking  methods  and  in  the  control  of  the  bank- 
ing situation  by  the  Imperial  Bank.  The  Imperial 
Bank  is  a  great  central  bank  controlled  by  the 
Government,  and  is  vested  with  the  power  as  well 
as  with  the  duty  to  regulate  and  to  protect  financial 
conditions  throughout  the  empire.  It  commonly 
holds  reserves  amounting  to  40  per  cent,  of  its 
aggregate  deposit  liabilities  and  note  issues.  Even 
in  times  of  money  stringency,  the  uncovered  note 
issues  of  the  German  banks,  both  absolutely  and 
per  capita  of  population,  are  less  than  one-half 
as  large  as  the  uncovered  note  issues  of  the 
National  banks  outstanding  at  all  times.  Fur- 
thermore, never  under  any  circumstances  can  the 
Imperial  Bank  issue  notes  to  an  amount  exceed- 
ing three  times  the  amount  of  coin  held  in  its 
reserves. 

The  only  effect  of  taxation  upon  bank-note  issues 
is  to  render  them  expensive  and  to  prevent  the 
banks  from  issuing  notes  before  interest  rates  have 
become  high.  But  the  prevalence  of  a  high  rate 
of  interest  in  Wall  Street,  which  probably  would 
induce  the  issue  of  notes,  would  afford  no  test  or 

63 


THE  BANKING  AND  CURRENCY  PROBLEM 

indication  of  the  probable  safety  of  an  issue  of 
more  notes  or  of  a  further  expansion  of  credits. 
At  best,  a  highly  taxed  issue  of  bank-notes  is  a 
so-called  "emergency  circulation"  available  only 
in  times  of  stress  and  panic.  It  is  of  no  avail  as 
a  means  of  preventing  a  money  stringency  and  pos- 
sible panic.  It  does  not  furnish  a  means  of  in- 
creasing the  bank  reserves  or  of  restraining  the 
banks  from  unduly  expanding  credits  in  times 
when  money  is  easy,  so  that  they  may  be  able  to 
reduce  their  reserves  or  to  expand  their  credits 
when  a  period  of  stringency  is  threatened.  Taxa- 
tion does  not  add  in  the  least  to  the  security  of 
bank-notes  or  to  the  ability  of  the  banks  to  pay 
their  depositors  and  note-holders  in  lawful  money 
on  demand. 

The  Aldrich-Vreeland  Act  was  passed  May  30, 
1908,  as  a  temporary  measure  of  protection  against 
severe  money  stringencies  or  panics  that  might 
occur  prior  to  the  enactment  of  a  permanent  meas- 
ure pursuant  to  the  recommendations  of  the  Na- 
tional Monetary  Commission.  Therefore,  this  Act 
should  not  be  criticised  as  though  it  were  designed 
to  be  a  permanent  addition  to  our  currency  laws. 
However,  it  is  proper  to  observe  that  the  Act  fur- 
nishes no  means  of  regulating  bank  credits,  and 
that  it  contains  no  provisions  intended  to  prevent 
the  over-expansions  of  credit  which  cause  money 

64 


IN  THE  UNITED  STATES 

stringencies  and  panics.  The  Act  authorizes  the 
National  banks,  under  certain  conditions,  to  issue 
additional  notes  upon  payment  of  a  tax  upon  such 
notes  when  in  circulation,  at  the  rate  of  5  per  cent, 
per  annum  for  the  first  month  with  a  monthly  in- 
crease at  the  rate  of  i  per  cent,  per  annum  for  each 
subsequent  month  until  the  rate  of  the  tax  shall 
have  reached  10  per  cent,  per  annum.  The  Act 
includes  no  provision  for  increasing  the  bank  re- 
serves during  periods  of  easy  money,  nor  any  in- 
ducements to  the  banks  to  hold  back  part  of  their 
power  to  grant  credits  for  use  in  times  of  money 
stringency  or  panic.  At  best,  the  Act  is  a  measure 
to  mitigate  money  stringencies  and  panics  after  the 
event. 

The  apparent  purpose  of  the  Act  was  to  enable 
the  banks  to  avoid  a  depletion  of  their  reserves 
and  the  resulting  violent  contraction  of  their  credit 
powder  when  depositors  withdraw  a  large  amount 
of  lawful  money  for  use  as  a  circulating  medium 
or  to  be  hoarded.  These,  however,  are  not  the 
only  conditions  under  which  the  banks  can  issue 
notes  under  the  Act.  The  banks  are  enabled  to 
issue  the  notes  in  case  of  any  severe  money  strin- 
gency, though  resulting  from  an  expansion  of  cred- 
its beyond  the  limit  of  safety.  The  banks  can 
issue  the  notes  whenever  the  prevailing  interest  rate 
shall  be  so  high  that  they  can  afford  to  pay  the  tax 

65 


THE  BANKING  AND  CURRENCY  PROBLEM 

imposed  by  the  Act  rather  than  to  diminish  their 
reserves  and  curtail  their  loans. 


Regulation  by  Government  Note  Isswe 

It  has  been  argued  persistently  that  the  issue  of 
notes  for  use  as  currency,  like  the  coinage  of  the 
precious  metals,  is  a  Governmental  function  that 
should  be  exercised  exclusively  by  Government, 
and  that  it  should  not  be  delegated  to  the  banks. 
It  also  has  been  urged  that  financial  conditions 
can  be  regulated  adequately  through  the  issue  of 
Government  notes.  The  answer  to  these  conten- 
tions is  that  it  is  not  true  that  the  issue  and  re- 
demption of  Government  notes  to  supply  and  to 
regulate  the  currency  ever  has  been  considered  by 
any  nation  to  be  a  Governmental  function,  and 
that  it  would  be  wholly  impracticable  to  regulate 
financial  conditions  by  the  issue  and  redemption 
of  Government  notes.  No  nation  ever  has  resorted 
to  an  issue  of  Government  notes,  except  in  times 
of  stress  and  trouble  and  low  national  credit,  and 
invariably  such  issues  have  proved  in  the  end  a 
source  of  trouble  and  danger.  Our  own  Govern- 
ment notes  were  issued  in  war  times,  and  subse- 
quently caused  untold  financial  troubles  and  losses 
to  the  people  of  the  United  States.  At  present 
these  notes  have  been  rendered  innocuous  by  the 

66 


IN  THE  UNITED   STATES 

limitation  of  their  issue  and  by  the  Government's 
pledge  to  redeem  them  on  demand  in  gold  and  to 
maintain  a  large  reserve  of  gold  for  that  purpose. 
To  extend  the  issue  of  such  notes  would  be  to  invite 
a  return  of  the  financial  evils  from  which,  for  more 
than  ten  years  after  the  war,  the  country  grievously 
suffered. 

How  could  an  issue  of  Government  notes  be  made 
elastic,  so  as  to  contract  when  contraction  is  neces- 
sary for  the  safety  of  the  credit  situation  of  the 
country  ?  How  could  an  issue  of  Government  notes 
be  used  as  a  means  of  regulating  the  general  credit 
situation?  How  could  it  be  used,  when  interest 
rates  are  very  low,  as  a  means  of  preventing  the 
over-expansions  of  credits  which  cause  subsequent 
money  stringencies  and  panics?  The  present  vol- 
ume of  Government  notes  and  National-bank  notes 
is  excessive  in  dull  times.  Is  it  proposed  in  dull 
times  to  redeem  and  cancel  some  of  the  existing 
Government  notes  and  National-bank  notes?  If 
not,  then  an  issue  of  more  Government  notes  would 
mean  only  further  expansion.  But,  even  if  reg- 
ulation were  possible  by  the  issue  and  redemption 
of  Government  notes,  can  any  one  having  the  least 
familiarity  with  actual  conditions  and  with  the 
teachings  of  history  believe  that  it  would  be  safe 
and  wise  to  vest  in  the  Government  a  discretionary 
power  to  increase  or  to  diminish  the  currency  of  the 

67 


THE  BANKING  AND  CURRENCY  PROBLEM 

country,  so  that  the  amount  of  the  currency  and  the 
expansion  of  bank  credits,  from  time  to  time,  would 
be  dependent  wholly  upon  the  will  of  the  President 
or  of  the  Secretary  of  the  Treasury  ? 

This  plan  suggests  other  questions  that  demand 
consideration.  How  would  the  Government  put 
its  notes  out?  It  could  not  give  them  away. 
Either  it  must  suspend  the  levying  of  taxes  and 
pay  its  debts  by  issuing  its  own  promissory  notes, 
or  it  must  lend  its  notes  to  the  banks.  On  what 
terms  and  on  what  security  would  the  Government 
lend  its  credit  to  the  banks ;  and  with  seven  thou- 
sand clamorous  National  banks,  how  could  this  be 
done  without  favoritism? 

Again,  would  the  Administration  be  empowered 
to  issue  notes  without  limit?  If  not,  how  would 
the  limit  be  fixed? 

It  is  assumed,  of  course,  that  the  Government 
notes  would  not  be  irredeemable  fiat  money,  but 
that  they  would  be  payable  on  demand  in  gold. 
Then  the  Government,  at  all  times,  would  have  to 
maintain  an  adequate  reserve  of  gold,  and  be  pre- 
pared to  pay  in  gold  all  notes  as  presented.  How 
would  the  Government  obtain  the  supply  of  gold 
as  needed? 

Does  any  one  believe  that  it  would  be  wise  to 
inject  such  questions  into  party  politics  ?  In  view 
of  the  financial  heresies  that  sometimes  have  pre- 

68 


IN  THE  UNITED  STATES 

vailed  and  still  are  extant,  and  in  view  of  our  politi- 
cal methods,  any  plan  of  issuing  additional  Govern- 
ment notes  in  the  United  States,  even  under  the 
most  careful  original  safeguards,  would  produce 
endless  uncertainty  and  political  agitation,  and  in- 
evitably would  tend  to  financial  disaster. 


The  European  System  of  Commercial  Credits 

It  has  been  asserted  that,  in  large  part,  the 
stability  and  the  safety  of  financial  conditions  in 
Europe  are  due  to  the  European  system  of  com- 
mercial credits,  and  that  satisfactory  financial  con- 
ditions cannot  be  secured  in  the  United  States 
except  by  the  adoption  of  a  similar  system. 

In  Europe,  when  a  merchant  buys  goods  on 
credit  from  another  merchant,  or  from  a  manu- 
facturer, in  many  cases  the  seller  of  the  goods 
draws  for  the  price  either  upon  the  purchaser,  if 
the  latter  has  an  established  credit,  or  upon  bankers 
with  whom  the  purchaser  previously  has  arranged 
that  they  shall  lend  him  their  credit  up  to  a  certain 
amount  by  accepting  bills  drawn  for  the  price  of 
goods  bought  in  the  course  of  his  business.  In 
such  case  the  purchaser  undertakes  to  furnish  the 
bankers  with  funds  for  the  payment  of  their  ac- 
ceptances when  due,  and  sometimes  the  goods  and 
their  proceeds  are  pledged  as  security.     Foreign 

69 


THE  BANKING  AND  CURRENCY  PROBLEM 

bills  commonly  are  drawn  upon  bankers,  with  the 
documents  for  the  goods  attached.  Such  a  bill  of 
exchange,  bearing  the  name  of  an  undoubtedly 
good  acceptor  in  addition  to  the  name  of  the 
drawer,  can  be  sold  readily  to  a  bank  at  the  cur- 
rent rate  of  discount,  and  the  drawer  of  the  bill 
is  enabled  thus  to  obtain  funds  if  desired  prior  to 
the  maturity  of  the  bill. 

In  the  United  States  the  practice  generally  is 
different.  When  a  merchant  buys  goods  on  credit 
the  seller  does  not  draw  upon  the  purchaser  or 
upon  bankers  for  his  account,  nor  does  the  pur- 
chaser give  his  note  for  the  price  of  the  goods. 
Usually  the  seller  contents  himself  with  an  account 
receivable  payable  after  thirty  days  or  more.  The 
seller  receives  no  commercial  paper,  and  if  he  should 
need  funds  before  maturity  of  the  book  account  he 
must  borrow  from  the  banks  upon  his  paper,  with 
or  without  accommodation  indorsement.  If,  in 
order  to  obtain  the  benefit  of  trade  discounts  for 
prompt  payment,  the  purchaser  should  desire  to 
pay  cash,  he  would  commonly  borrow  the  neces- 
sary funds  upon  his  own  note. 

The  European  system  undoubtedly  has  ad- 
vantages over  the  American  system.  The  seller 
of  goods  is  safer,  because  he  receives  commercial 
paper  bearing  the  name  of  an  acceptor  of  high 
credit,  and  this  paper  can  be  discounted  without 

70 


IN   THE   UNITED  STATES 

difficulty.  For  the  same  reason  the  several  banks 
which  discount  such  paper  also  are  safer.  Further- 
more, though  the  European  system  of  commercial 
credits  involves  the  creation  of  bank  credit  in  the 
same  amount  as  the  American  system,  it  is  better 
for  the  general  credit  situation.  This  is  so  because 
commercial  paper  created  under  the  European 
system  is  a  more  salable  asset  in  the  hands  of  the 
banks  than  the  single  name  or  accommodation 
paper  created  under  the  American  system.  The 
several  banks  can  carry  smaller  reserves  in  Europe 
than  in  the  United  States  because,  in  case  of  need, 
such  commercial  paper  can  be  rediscounted  readily 
either  at  their  central  bank  at  home  or  in  the  large 
commercial  centres  of  Europe. 

There  are  several  reasons,  however,  why  this 
European  system  of  commercial  credits  is  not 
available  as  a  means  of  preventing  the  financial  dis- 
turbances which  often  occur  in  the  United  States. 
One  reason  is  that  this  system  is  not  in  accordance 
with  our  business  methods  and  habits,  and  it  is 
not  practicable,  by  legislation,  to  revolutionize  the 
business  methods  and  habits  of  the  people.  An- 
other reason  is  that  it  is  doubtful  whether  the  in- 
troduction of  this  European  system  would  have  a 
far-reaching  effect,  inasmuch  as  the  legitimate  com- 
mercial credits  granted  by  the  banks  in  the  United 
States  are  not  the  principal  source  of  danger  to  the 

71 


THE  BANKING  AND  CURRENCY  PROBLEM 

general  credit  situation.  A  third  reason  is  that  the 
principal  advantage  of  the  European  system  can 
be  obtained  only  after  establishing  more  stable 
financial  conditions  and  more  stable  interest  rates, 
so  that  the  holders  of  commercial  paper  may  be  sure 
of  a  ready  market  for  such  paper  at  a  reasonable 
rate  of  discount. 

The  European  system  of  commercial  credits  is 
the  result,  and  is  not  the  cause,  of  stable  financial 
conditions.  In  the  United  States  the  first  step 
should  be  to  secure  reasonable  stability  of  credit 
conditions  and  of  interest  rates  by  providing  the 
necessary  central  regulation.  After  securing  such 
necessary  stability,  it  is  probable  that  the  more  de- 
sirable credit  methods  used  in  foreign  countries 
would  be  adopted  in  the  United  States,  and  New 
York,  like  London  and  Berlin,  would  become  a 
market  for  international  commercial  credits. 


Guarantee  of  Bank  Deposits 

It  has  been  proposed  to  tax  all  the  National 
banks  ratably,  according  to  their  deposits,  to  pro- 
vide a  guarantee  fund  for  the  prompt  payment  of  the 
depositors  of  every  broken  bank;  and  it  has  been 
asserted  that  the  adoption  of  this  plan  would  give 
to  bank  depositors  such  confidence  that  there  would 
be  no  more  runs  upon  banks  and  no  more  financial 

72 


IN    THE  UNITED  STATES 

panics.  Although  during  the  last  presidential  cam- 
paign this  plan  was  made  an  issue,  and  was  rejected 
by  popular  vote,  its  merits  should  be  considered 
without  regard  to  party  politics  or  party  feeling. 

Many  have  been  induced  to  look  with  favor  upon 
this  plan  to  guarantee  bank  deposits  because  they 
have  been  assured  that  it  would  protect  innocent 
people  who  have  deposited  their  savings  in  the 
banks,  and  that  in  order  to  bring  about  a  result  so 
beneficent  all  banks  could  well  afford  to  pay  a  small 
tax  upon  deposits.  It  should  be  borne  in  mind, 
however,  that  only  a  small  percentage  of  the  so- 
called  deposits  of  the  National  banks  are  savings 
deposits  or  represent  any  deposit  of  money.  The 
larger  part  of  these  so-called  deposits  represent 
merely  exchanges  of  credits  for  business  purposes 
between  the  banks  and  their  so-called  depositors. 
Such  transactions  are  perfectly  honest  and  proper, 
but  it  is  absurd  to  assume  that  these  exchanges  of 
credit  between  business  men  and  the  banks  are  so 
highly  meritorious  that  the  Federal  Government 
should  exercise  paternal  care  for  their  protection  by 
establishing  a  system  of  compulsory  insurance  at 
the  expense  of  the  banks,  and  by  requiring  the 
sound  and  conservative  banks  to  pay  the  losses  of 
those  people  who  choose  to  deal  with  unsound 
and  reckless  banks. 

The  aggregate  losses  suffered  by  the  depositors  of 
6  73 


THE  BANKING  AND  CURRENCY  PROBLEM 

failed  National  banks  by  reason  of  the  ultimate 
insufficiency  of  their  assets  to  pay  off  depositors  in 
full  have  been  very  small — less  than  one-twentieth 
of  one  per  cent.  They  have  been  infinitesimal  com- 
pared with  the  losses  of  the  people  through  bad 
debts,  fraud,  speculation,  gambling,  indulgence  in 
drink,  and  other  causes  largely  preventable  and 
equally  deserving  of  the  paternal  attention  of  the 
Government.  If,  however,  it  should  be  deemed  of 
paramount  importance  to  establish  a  system  of 
compulsory  insurance  for  the  protection  of  savings 
depositors,  the  proper  course  would  be  to  confine 
this  system  strictly  to  savings  deposits,  and  to  pay 
for  the  insurance  out  of  the  interest  which  other- 
wise would  be  paid  by  the  banks  to  the  depositors. 
The  first  step  in  that  direction  would  be  to  au- 
thorize the  National  banks  to  establish  separate 
savings  departments,  to  be  managed  under  the 
supervision  of  the  Comptroller  of  the  Currency  ac- 
cording to  the  most  approved  methods  of  managing 
savings-banks. 

The  whole  plan  for  the  guarantee  of  bank  de- 
posits is  the  result  of  a  confusion  of  ideas  and  of  a 
misconception  as  to  banking  processes.  Though 
by  a  guarantee,  or  insurance  fund,  it  might  be 
possible  to  protect  the  depositors  of  failed  banks 
against  the  small  ultimate  losses  that  may  appear 
upon  final  winding  up  of  the  banks,  it  would  be 

74 


IN  THE  UNITED  STATES 

absolutely  impossible  to  assure  such  a  sufficiency 
of  cash  reserves  that  the  depositors  of  every  sus- 
pending bank  would  receive  payment  promptly  on 
demand. 

If  the  plan  be  to  insure  prompt  payment  of  the 
depositors  of  a  bank  immediately  upon  its  failure, 
and  not  merely  to  make  good  any  ultimate  losses  of 
depositors  upon  the  final  winding  up,  the  amount  of 
cash  necessary  would  be  simply  enormous.  The 
money  contributed  by  the  banks  to  the  insurance 
fund  either  would  be  locked  up  by  the  Government, 
or  it  would  be  invested  in  securities,  or  it  would 
be  redeposited  in  the  banks.  If  the  money  were 
locked  up  by  the  Government  the  effect  would  be  in 
exactly  that  amount  to  reduce  the  bank  reserves, 
with  the  consequent  larger  reduction  of  the  power 
of  the  banks  to  make  loans  and  grant  credits.  In 
other  words,  the  reserves  of  the  banks  and  their 
power  to  grant  credits  would  each  be  reduced.  If 
the  money  were  invested  in  securities  and  thus  re- 
turned to  circulation,  the  securities  could  be  re- 
converted into  cash  only  by  sale,  and  in  that  event 
the  purchase  money  would  be  drawn  from  the 
banks,  thereby  again  diminishing  their  reserves 
and  their  credit  power;  a  result  most  liksly  to  hap- 
pen at  the  very  time  when  the  banks  could  least 
afford  to  diminish  their  reserves  or  to  contract  their 
credits.    Finally,  if  the  money  contributed  to  the 

75 


THE  BANKING  AND  CURRENCY  PROBLEM 

guarantee  fund  were  to  be  redeposited  in  the  banks, 
the  only  change  in  the  situation  would  be  that  the 
banks  would  have  exactly  the  same  reserves  as 
before,  but  subject  to  calls  upon  their  reserves  in 
order  to  pay  off  the  depositors  of  any  banks  that 
may  fail.  At  best,  therefore,  the  plan  would  operate 
as  a  compulsory  pooling  of  part  of  the  reserves  of 
the  banks — the  reserves  of  the  prudent  and  sound 
banks  to  that  extent  being  made  subject  to  calls 
for  the  payment  of  depositors  in  banks  that  are 
unsound  or  badly  managed. 

What,  then,  would  be  the  effect  of  the  plan  ?  In 
good  times  and  with  prosperous  business  the  weak- 
er and  speculative  banks  would  be  encouraged  to 
expand  their  credits  and  to  increase  their  loans, 
but  in  times  of  stringency  and  threatened  trouble 
the  strong  and  conservative  banks  would  be  forced 
to  contract  credits  and  to  refuse  accommodation 
to  their  customers  because  of  the  necessity  of  main- 
taining and  building  up  their  reserves  to  meet  de- 
mands for  cash  to  pay  off  depositors  of  failing 
banks.  In  times  of  money  stringency  and  threat- 
ened trouble  the  strong  banks  would  be  forced  to 
be  doubly  conservative  because  they  would  have 
to  be  prepared  to  meet  unknown  demands,  the 
amount  of  which  they  could  not  foresee,  and  against 
which  the  utmost  caution  and  foresight  would  not 
protect  them.     The  tendency  of  the  plan,  there- 

76 


IN  THE  UNITED  STATES 

fore,  would  be  to  cause  expansion  of  bank  credits 
when  conservatism  is  desirable,  and  to  cause  con- 
traction of  bank  credits  when  credit  is  most  needed 
to  prevent  panic  and  disaster. 

No  guarantee  fund,  nor  any  system  of  insiiring 
bank  depositors,  can  possibly  furnish  a  substitute 
for  cash  reserves.  At  best  the  plan  would  be  but 
an  illustration  of  a  man  trying  to  lift  himself  over 
a  fence  by  his  own  boot-straps.  The  plan  would 
not  increase  the  bank  reserves  by  one  dollar,  and 
would  not  in  the  least  strengthen  the  general  bank- 
ing situation.  It  would  weaken  the  strong  banks 
far  more  than  it  would  strengthen  the  weak  banks. 
It  would  tie  all  the  banks  together,  the  good  and 
the  bad,  so  that  in  the  event  of  great  stress  and 
trouble  all  would  be  likely  to  fall  together  in  one 
general  ruin. 

The  assumption  that  the  proposed  guarantee  of 
bank  deposits  would  give  to  depositors  such  con- 
fidence that  there  would  be  no  more  runs  upon 
banks,  and  therefore  no  more  bank  panics,  also  is 
unfounded.  Rims  upon  banks  by  small  depositors 
who  wish  to  draw  out  cash  for  hoarding  are  not  the 
principal  causes  of  bank  suspensions.  If  people 
cease  to  make  new  deposits  in  a  bank,  or  if  the 
larger  depositors  deliver  their  checks  to  other 
banks  for  collection,  it  may  be  forced  to  suspend, 
though  there  be  no  visible  run  of  depositors.     But 

77 


THE  BANKING  AND  CURRENCY  PROBLEM 

what  reason  is  there  to  assume  that  the  adoption 
of  this  plan  would  inspire  confidence  and  prevent 
runs  upon  banks?  As  already  indicated,  the 
adoption  of  the  plan  would  not  in  the  least  increase 
the  ability  of  the  banks  collectively  to  pay  de- 
positors on  demand,  or  strengthen  the  general 
situation,  and  it  would  result  in  tying  all  the  banks 
together,  so  that  in  times  of  stress  and  trouble  all 
would  have  to  suspend.  The  utmost  possible  of 
accomplishment  would  be  to  insure  that,  upon 
final  winding  up,  the  depositors  of  the  unsound 
banks  would  be  paid  in  full  at  the  expense  of  the 
sound  banks.  Would  the  belief  of  depositors  that 
in  case  of  the  failure  of  their  bank  they  will  get 
their  money  in  a  year  or  more,  and  that  in  the 
mean  time  general  financial  disaster  may  over- 
whelm the  country,  be  likely  to  prevent  them  from 
trying  to  get  their  money  as  soon  as  possible? 

But  even  if  it  were  true  that  the  adoption  of  this 
plan  would  make  equally  safe  all  deposits  in  Na- 
tional banks,  thereby  inspiring  confidence  in  all 
National  bank  deposits,  the  plan  would  prove 
a  direct  encouragement  to  "wildcat"  banking, 
and  ultimately  would  prove  disastrous.  It  would 
enable  speculators  or  inexperienced  persons  to 
form  a  bank  with  small  capital,  and  on  the  strength 
of  this  guarantee  to  obtain  large  deposits  by  offer- 
ing to  allow  rates  of  interest  higher  than  could  be 

78 


IN  THE  UNITED  STATES 

afforded  by  a  conservatively  managed  bank;  and 
then  they  could  use  these  deposits  in  promoting 
speculative  or  unsound  ventures.  They  would  risk 
the  loss  of  only  the  small  capital  which  they  con- 
tributed and  their  individual  liability  for  an  equal 
amount.  Should  their  speculations  succeed  they 
would  reap  large  profits,  but  if  their  speculations 
should  fail  and  the  money  obtained  from  depositors 
be  wasted,  the  loss  w^ould  fall  upon  the  sound 
banks. 


State  Banks  and  Trust  Companies 

The  report  of  the  Comptroller  shows  that  in 
June,  1907,  there  existed  in  the  United  States 
19,746  banks  and  trust  companies,  classified  as 
follows : 

Number.  Capital.  Individual  Deposits. 

National  banks 6,429  $883,700,000  $4,322,900,000 

State   banks 9.967  471,663,037  3,068,649,860 

Trust  companies 794  276,146,081  2,061,623,035 

Savings-banks 1,415  34.224,322  3,495,410,087 

Private  banks 1,141  25,144,822  151,072,225 

Total    19,746  $1,690,878,262  $13,099,655,207 

In  addition,  there  were  numerous  non-reporting 
companies  and  firms  doing  a  banking  business,  some 
of  them  receiving  large  deposits  and  engaging  in 
banking  operations  on  a  large  scale. 

It  has  been  urged  that  the  failure  of  one  or  of  a 
79 


THE  BANKING  AND  CURRENCY  PROBLEM 

few  of  the  large  State  banks  or  trust  companies 
may  precipitate  a  general  panic  involving  all  the 
banks  and  trust  companies  in  the  country,  and  that, 
therefore,  no  sound  system  of  banking  and  currency 
can  be  established  in  the  United  States  unless  the 
various  State  banks  and  trust  companies,  as  well  as 
the  National  banks,  are  subjected,  by  Act  of  Con- 
gress, to  some  system  of  uniform  inspection  and 
regulation. 

In  the  opinion  of  the  writer,  this  view  is  not  well 
founded.  The  serious  financial  troubles  in  the 
United  States  have  not  been  due  to  dishonesty  or 
bad  judgment  in  the  management  of  individual 
banks  or  trust  companies.  They  have  been  due 
to  the  absence  of  intelligent  central  regulation  of 
the  general  credit  situation,  and  to  the  absence  of  a 
central  power  to  provide  for  unexpected  demands 
for  currency  and  for  unexpected  strains  upon  the 
general  banking  situation.  Without  this  central 
regulation  and  control  no  system  of  uniform  in- 
spection and  regulation  of  the  several  banks  and 
trust  companies  would  render  the  banking  situation 
safe.  Undoubtedly  the  existence  of  diverse  State 
banks,  trust  companies,  and  private  banking  firms 
emphasizes  the  necessity  that  some  central  au- 
thority shall  be  established  with  power  to  regulate 
and  to  protect  the  general  banking  situation;  but 
foreign  experience  shows  that  where  such  a  central 

80 


IN  THE  UNITED  STATES 

power  exists,  the  individual  banks,  in  great  meas- 
ure, can  be  left  to  take  care  of  themselves,  and 
that  close  regulation  of  the  individual  banks  is  not 
necessary  to  insure  the  safety  of  the  general  credit 
situation.  In  England  there  are  many  joint  stock 
banks  which,  though  doing  an  enormous  volume  of 
business,  are  subject  to  very  little  regulation  and 
many  private  banking  firms  that  are  subject  to  no 
regulation  at  all.  Yet  it  has  been  found  practicable, 
through  the  Bank  of  England,  to  keep  the  general 
financial  situation  sound  and  safe,  and  to  meet 
extraordinary  conditions,  like  those  caused  by  the 
failure  of  the  great  international  house  of  Baring 
Brothers  &  Co.  Similar  conditions  prevail  in 
France  and  Germany. 

By  the  establishment  of  a  central  agency  em- 
powered to  regulate  the  issue  and  redemption  of 
currency  by  the  National  banks,  the  general  ex- 
pansion of  credits  could  be  regulated  and  the  safety 
of  the  general  banking  situation  could  be  insured 
without  subjecting  the  State  banks  and  trust  com- 
panies to  National  regulation.  Under  such  cir- 
cumstances the  regulation  of  the  individual  affairs 
of  the  several  State  banks  and  trust  companies  and 
private  banking  firms  would  not  be  a  matter  of 
National  concern.  It  is  believed  that  the  plan 
herewith  submitted  would  furnish  a  means  of  reg- 
ulating and  protecting  banking  conditions  through- 

8i 


THE  BANKING  AND  CURRENCY  PROBLEM 

out  the  country  as  effective  as  that  existing  in 
Germany,  and  a  method  much  more  effective  than 
the  English  system. 

Grave  constitutional  and  practical  difficulties 
would  embarrass  any  attempt  to  regulate  the  en- 
tire banking  business  of  the  United  States  by  Act 
of  Congress.  The  Constitution  does  not  confer  upon 
Congress  power  to  regulate  the  banking  business, 
nor  does  it  confer  upon  Congress  power  to  regulate 
corporations.  Therefore,  any  National  legislation  for 
the  regulation  of  the  banking  business,  or  for  the 
regulation  of  banking  corporations  organized  under 
State  laws,  could  be  sustained  only  so  far  as  such 
regulation  should  constitute  a  proper  exercise  of 
some  other  power  expressly  vested  in  Congress  by 
the  Constitution.  The  Act  of  Congress  imposing  a 
tax  of  loper  cent,  on  State  bank-notes  was  sustained 
by  the  Supreme  Court,  partly  as  an  exercise  of  the 
taxing  power  of  the  Federal  Government  and  partly 
as  an  incident  to  the  power  of  Congress  to  coin 
money  and  to  issue  bills  of  credit.  Possibly  the 
Supreme  Court  rr^'ght  sustain  legislation  prohibit- 
ing all  banks,  except  those  regulated  by  Act  of 
Congress,  from  engaging  in  transactions  directly 
connected  with  interstate  commerce,  and  possibly 
the  Supreme  Court  might  even  sustain  legislation 
affecting  the  right  to  use  bank  checks  and  drafts 
in  interstate  commerce,  on  the  ground  that  such 

82 


IN   THE   UNITED  STATES 

legislation  would  be  an  exercise  of  the  power  of 
Congress  to  regulate  interstate  commerce ;  but  there 
appears  to  be  no  basis  for  sustaining  the  con- 
stitutionality of  an  Act  of  Congress  regulating  the 
business  of  receiving  deposits  and  of  making  loans 
or  discounting  paper. 

The  proposal  indirectly  to  regulate  the  banking 
business  through  the  taxing  power  should  not  be 
countenanced,  for  it  would  evade  the  spirit  of  the 
Constitution,  even  though  the  courts  should  feel 
obliged  to  uphold  such  legislation  because  of 
their  unwillingness  to  scrutinize  the  reasonable- 
ness of  a  tax  or  the  motive  of  Congress  in  impos- 
ing it. 

Though  it  may  be  desirable  to  subject  all  the 
State  banks  and  trust  companies  to  uniform  Na- 
tional regulation,  it  is  to  be  borne  in  mind  that  there 
are  also  many  other  subjects  which  it  would  be 
desirable  to  regulate  by  uniform  National  legislation, 
but  under  our  system  of  Constitutionl  government 
such  legislation  is  impossible.  Any  attempt  to 
prohibit  the  banking  business  under  State  laws  or 
to  subject  the  State  banks  and  trust  companies  to 
National  regulation  would  involve  serious  consti- 
tutional and  practical  difficulties,  and  in  most  of 
the  States  probably  would  meet  with  popular  dis- 
approval. 

83 


THE  BANKING  AND  CURRENCY  PROBLEM 

How  Central  Regulation  can  be  Secured 

If  the  views  herein  expressed  are  correct,  no 
safe  and  sound  system  of  banking  and  currency  is 
possible  without  some  central  agency  having  power 
to  control  the  expansion  of  bank  credits  in  the 
aggregate  in  relation  to  bank  reserves  in  the  aggre- 
gate, and  power  also  to  protect  the  general  credit 
situation  in  case  of  an  unexpected  strain  upon  the 
banks  by  the  withdrawal  of  large  sums  from  their 
cash  reserves. 

In  England  the  necessary  central  control  and 
protection  are  obtained  through  the  Bank  of  Eng- 
land by  raising  or  lowering  its  discount  rate.  By 
raising  its  discount  rate  the  bank,  to  some  extent, 
can  raise  the  current  interest  rate  in  the  London 
market,  and  thereby  can  limit  the  expansion  of 
credits  and  cause  gold  to  flow  to  England,  thus 
increasing  the  bank  reserves.  The  Bank  of  Eng- 
land cannot  control  or  protect  the  credit  situation 
by  means  of  note  issues.  Except  as  to  about 
ninety  million  dollars  of  notes  issued  against  Gov- 
ernment securities,  the  Bank  of  England  cannot 
issue  notes  without  receiving  and  holding  in  its 
issue  department  an  equal  amount  of  gold,  so  that 
the  issue  and  redemption  of  Bank  of  England  notes 
does  not  affect  the  volume  of  currency  in  the 
country  or  the  reserves  of  the  bank  against  de- 

84 


IN  THE  UNITED  STATES 

posit  liabilities  incurred  in  its  discount  depart- 
ment. 

The  great  prestige  and  power  of  the  Bank  of 
England  are  based  largely  upon  long-established 
traditions  and  business  habits.  In  the  United 
States  no  additional  legislation  would  be  required 
to  establish  such  a  bank,  except  to  constitute  it 
the  sole  depositary  of  Government  moneys.  The 
fact  that  no  such  bank  has  been  created  in  the 
United  States  is  some  indication  that  such  a  bank 
would  not  be  in  harmony  with  our  institutions 
and  that  it  could  not  be  established. 

But,  even  though  it  were  practicable  to  create 
here  a  central  bank  with  the  prestige  and  power 
of  the  Bank  of  England,  the  English  system  would 
not  prove  adequate  in  a  country  as  large  as  the 
United  States,  or  in  a  country  in  which  the  demand 
for  bank  credits  and  the  demand  for  currency  as 
a  circulating  medium  fluctuate  as  widely  and  as 
rapidly  as  in  the  United  States.  Unless  the  por- 
tion of  the  country's  banking  power  concentrated 
in  the  central  bank  were  larger  than  in  England, 
any  attempt  to  regulate  bank  credits  and  reserves 
by  changing  the  discount  rate  of  the  central  bank 
would  prove  ineffective  and  certainly  would  be  too 
slow.  Even  in  England  the  English  system,  prob- 
ably, would  not  have  proved  workable  if  England 
were  not  largely  a  creditor  nation  and  London  a 

85 


THE  BANKING  AND  CURRENCY  PROBLEM 

clearing-house  for  commercial  credits  throughout 
the  entire  world.  A  change  in  the  discount  rate 
of  the  Bank  of  England  has  an  immediate  and 
marked  effect  upon  the  entire  volume  of  inter- 
national drafts  drawn  upon  the  English  banks. 
Even  in  England  this  system  has  not  always  proven 
adequate,  as  is  shown  by  the  fact  that  on  several 
occasions  it  became  necessary  to  suspend  the  Bank 
Act  and  to  authorize  the  Bank  of  England  to  issue 
its  notes  without  adding  a  corresponding  amount  of 
gold  to  the  reserve  in  its  issue  department,  and  on 
several  occasions  the  Bank  of  England  found  it 
necessary  to  obtain  assistance  by  borrowing  gold 
from  the  Bank  of  France. 

The  most  effective  and  the  most  rapid  means  of 
regulating  and  protecting  the  general  credit  situa- 
tion is  by  increasing  or  diminishing  the  volume  of 
outstanding  bank-note  currency  not  covered  by 
a  reserve  of  gold  or  other  lawful  money.  This 
method  is  that  used  successfully  both  in  France 
and  in  Germany.  The  Bank  of  France  and  the 
Imperial  Bank  of  Germany  to  some  extent  regulate 
credit  conditions  by  acting  as  central  banks  of  dis- 
count ;  but  their  most  effective  action  is  by  increas- 
ing or  diminishing  the  uncovered  amount  of  their 
outstanding  notes.  When  additional  currency  is 
needed  as  a  circulating  medium  they  supply  this 
currency  by  issuing  notes.     When  contraction  of 

3^ 


IN  THE  UNITED  STATES 

the  currency,  or  a  check  upon  the  further  expansion 
of  bank  credits,  is  desirable,  they  accompHsh  the 
result  by  diminishing  the  volume  of  their  outstand- 
ing notes  and  by  raising  the  discount  rate. 


Plan  for  Central  Regtilation  in  the  United  States 

The  problem,  then,  is  to  establish  some  central 
agency  having  power  to  control  the  volume  of  un- 
covered bank-note  currency  in  the  United  States 
without  creating  a  central  bank  vested  with  a 
monopoly  of  the  power  to  issue  bank-notes  and  able 
to  dominate  all  the  banks  in  the  country. 

In  substance,  the  plan  now  submitted  is  to  au- 
thorize the  National  banks  to  issue  notes  upon 
their  joint  credit  and  to  control  the  uncovered 
amount  of  these  notes  by  the  joint  action  of  the 
Secretary  of  the  Treasury  and  of  a  managing  board, 
or  committee,  elected  by  the  banks. 

To  carry  out  this  plan,  an  Act  of  Congress  should 
be  passed  authorizing  the  National  banks  to  form 
an  association,  subject  to  terms  and  conditions 
prescribed  in  the  Act,  for  the  sole  purpose  of  issuing 
notes  upon  their  joint  credit.  The  association 
should  have  no  capital  and  should  not  have  power 
to  receive  deposits.  It  should  be  simply  a  joint 
agency  of  the  associated  banks,  like  a  large  clearing- 
house association.     The  association  should  become 

87 


THE  BANKING  AND  CURRENCY  PROBLEM 

operative  when  banks  having  a  fixed  aggregate 
capital  stock  of  not  less  than  two  hundred  and  fifty 
million  dollars  shall  have  become  members,  but  all 
National  banks  should  be  entitled  at  any  time  to 
join  the  association. 

The  banks  constituting  the  association  should 
elect  a  managing  board,  or  committee,  consisting 
of  fifteen  to  twenty-one  experienced  bankers  or 
business  men  familiar  with  general  conditions  and 
with  financial  operations,  and  this  managing  board 
should  control  the  affairs  of  the  association.  How- 
ever, as  the  entire  community  is  interested  in  the 
character  of  the  currency  and  in  the  stability  of 
financial  conditions  and  of  interest  rates,  no  action 
of  the  managing  board  affecting  the  volume  of  out- 
standing notes,  or  the  percentage  of  the  redemption 
fund  for  the  payment  of  the  notes,  should  be  effec- 
tive until  approved  by  the  Government  through  the 
Secretary  of  the  Treasury.  The  Comptroller  of  the 
Currency  should  be,  ex  officio,  a  member  of  the 
managing  board  of  the  association. 

The  elected  managers  of  the  association  should 
hold  office  for  three  years,  and  should  be  classified 
so  that  one-third  shall  be  elected  annually.  Each 
bank  should  have  one  vote  for  each  $25,000  of  its 
capital  stock  for  each  manager  to  be  elected  and 
should  have  power  to  cumulate  its  votes.  To  fix 
the  votes  of  the  several  banks  according  to  their 

88 


IN  THE  UNITED  STATES 

capital  stock  would  be  fair  and  would  prevent  any 
particular  class  of  banks  from  controlling  the 
association,  as  is  shown  by  the  following  figures 
taken  from  the  report  of  the  Comptroller  for  1907: 

Number  of  Aggretjate 

C'lP'tal-  Banks.  Capital. 

Less  than  $50,000 2,063  $54,322,000 

$50,000  and  not  over  $250,000 3.304  232,250,920 

Over  $100,000  but  not  over  $250,000.  .  .  .       741  135,379.585 

Over  $250,000  but  not  over  $1,000,000.  .  .       472  250,026,920 

Over  $1,000,000  but  not  over  $5,000,000.  .         64  139,080,700 

Over  $5,000,000 6  84,000,000 

Aggregate  of  all  kinds 6,650  $895,060,  125 


Branches  and  Agencies 

The  principal  office  of  the  association  should  be 
in  Washington,  and  the  association  should  be  re- 
quired to  establish  a  branch  or  agency  for  the 
issue  and  redemption  of  notes  in  each  city  in  which 
there  is  a  United  States  sub-treasury.  The  associa- 
tion should  be  permitted  to  establish  branches  and 
agencies  wherever  the  board  of  managers  may  deem 
advisable,  either  for  the  issue  and  redemption  of 
notes  or  only  for  the  redemption  of  notes.  It 
should  be  the  duty  of  the  association,  within  two 
years  after  it  has  commenced  operations,  to  es- 
tablish a  branch  or  agency  for  the  redemption  of 
notes  in  every  city  of  the  United  States  having  a 
population  of  one  hundred  thousand  persons. 
7  89 


THE  BANKING  AND  CURRENCY  PROBLEM 

Meetings  of  the  Board  of  Managers,  etc. 

The  managers  of  the  association  should  hold 
their  meetings  at  the  principal  office  in  Washing- 
ton, or  at  other  places  approved  by  the  Comptroller 
of  the  Currency.  Regular  meetings  of  the  board 
should  be  held  monthly,  and  there  should  be  an 
executive  committee  of  three  residing  in  Washing- 
ton and  holding  daily  meetings.  The  executive 
committee,  upon  receiving  the  approval  in  writing, 
or  by  telegraph,  of  a  majority  of  all  the  members 
of  the  board,  should  have  power  to  act  for  the 
whole  board  upon  any  proposal  to  increase  or  to 
diminish  either  the  authorized  volume  of  notes  or 
the  percentage  of  the  redemption  fund. 

The  board  of  managers  should  have  power  to  ap- 
point such  committees,  officers,  and  agents  as  they 
may  deem  advisable  for  the  management  of  the 
association  and  its  several  branches  and  agencies. 


Limit  of  Note  Issues  under  Plan 

Each  bank,  being  a  member  of  the  association, 
should  have  a  right  to  take  out  and  to  issue  notes 
up  to  an  amount  which,  including  its  present  bond- 
secured  notes,  shall  not  exceed  its  capital  stock. 
With  the  approval  of  the  Secretary  of  the  Treasury, 
the  managing  board  should  have  the  power  from 
time  to  time  to  increase,  ratably  as  to  all  banks,  the 

90 


IN  THE  UNITED  STATES 

authorized  amount  of  their  note  issues,  and  there- 
after to  reduce  any  such  increase  that  may  have 
been  authorized;  but  this  power  to  increase  the 
authorized  amount  of  the  note  issues  should  be 
limited  to  some  fixed  percentage  of  the  capital  stock 
of  the  banks.  No  bank  should  be  authorized  to 
take  out  notes  unless  its  capital  stock  be  wholly 
paid  up  and  unimpaired,  nor  if  it  be  in  de- 
fault in  depositing  and  keeping  up  its  note  -  re- 
demption fund  or  in  the  payment  of  any  sum  due 
to  the  association.  The  notes  should  be  prepared 
by  the  association,  under  the  supervision  of  the 
Comptroller  of  the  Currency,  and  every  act  of  the 
association  should  be  subject  to  the  supervision  of 
the  Comptroller. 


Redemption  Funds  under  the  Plan 

Each  bank  having  taken  out  notes  should  be  re- 
quired to  keep  on  deposit  with  the  association,  as  a 
redemption  fund  for  their  payment,  a  sum  of  lawful 
money  equal  to  20  per  cent,  of  such  notes,  or  such 
greater  per  cent,  thereof  as  from  time  to  time  may 
be  prescribed  by  the  board  of  managers  and  the 
Secretary  of  the  Treasury.  The  note  redemption 
funds  of  the  several  banks  should  be  administered 
by  the  board  of  managers,  under  the  supervision  of 
the  Comptroller  of  the  Currency. 

91 


THE  BANKING  AND  CURRENCY  PROBLEM 

Upon  taking  out  notes,  each  bank  would  be  re- 
quired to  deposit  in  its  note-redemption  fund  the 
prescribed  sum  of  lawful  money.  Whenever,  be- 
cause of  the  payment  of  notes  of  a  bank  out  of  its 
redemption  fund,  or  because  of  an  increase  of  the 
prescribed  percentage  of  the  redemption  funds,  the 
redemption  fund  of  any  bank  shall  fall  below  the 
percentage  then  prescribed  by  the  board  of  mana- 
gers and  the  Secretary  of  the  Treasury,  the  bank, 
upon  call  of  the  board  of  managers,  should  be  re- 
quired to  deposit  such  sum  as  may  be  necessary  to 
make  up  the  deficiency.  However,  in  order  to  avoid 
needless  multiplicity  of  calls  upon  the  banks,  the 
board  of  managers  should  not  be  obliged  to  call  upon 
a  bank  to  make  up  a  deficiency  amounting  to  less 
than  3  per  cent,  of  the  outstanding  notes  of  the  bank. 

The  great  function  of  the  board  of  managers,  in 
conjunction  with  the  Secretary  of  the  Treasury, 
would  be,  from  time  to  time,  to  fix  the  authorized 
limit  of  the  note  issues  of  the  several  banks  (if  any 
increase  beyond  their  capital  stocks  be  authorized) 
and  to  fix  the  amount  of  lawful  money  to  be  de- 
posited with  the  association  for  the  redemption  of 
the  notes. 

This  power  of  the  board  of  managers,  in  con- 
junction with  the  Secretary  of  the  Treasury,  to  in- 
crease or  to  diminish  the  percentage  of  the  note- 
redemption  funds,  would  enable  them  to  regulate  the 

92 


IN   THE  UNITED  STATES 

uncovered  volume  of  the  notes  outstanding  and  to 
give  stability  to  financial  conditions  generally.  It 
is  here  to  be  borne  in  mind  that  it  is  not  the  nominal 
amount  of  outstanding  bank-notes  that  counts,  but 
only  the  portion  of  the  notes  that  is  not  covered 
by  a  redemption  fund  or  reserve  of  legal  -  tender 
money.  The  issue  of  $1,200,000,000  of  bank-notes 
against  a  reserve  of  50  per  cent,  (or  $600,000,000) 
has  no  greater  effect  in  expanding  the  currency  and 
the  credit  power  of  the  banks  than  the  issue  of 
$631,578,947  of  bank-notes  with  a  redemption  fund 
or  reserve  of  5  per  cent.  In  each  case  the  net  in- 
crease of  the  currency  would  be  $600,000,000,  that 
being  the  amount  of  notes  not  covered  by  the  re- 
demption fund  or  reserve  of  lawful  money. 

However,  there  are  advantages  in  using  a  large 
note  issue  with  a  large  percentage  of  reserve  rather 
than  a  small  note  issue  with  a  small  percentage  of 
reserve,  partly  because  the  use  of  bank-notes  is 
more  convenient  than  the  use  of  gold  and  saves 
loss  by  abrasion,  and  partly  because  the  use  of 
notes  covered  by  a  large  reserve  renders  it  com- 
paratively easy  to  expand  the  currency  in  case  of 
a  sudden  demand  by  reason  of  a  panic  or  other 
cause.  Thus,  with  a  reserve  of  $600,000,000 
against  outstanding  notes  amounting  to  $1,200,- 
000,000,  it  would  be  practicable,  in  case  of  need, 
to  empower   the  banks  to  issue  $600,000,000  of 

93 


THE  BANKING  AND  CURRENCY  PROBLEM 

additional  notes  against  this  reserve  by  reducing 
from  50  to  333-  per  cent,  the  required  percentage 
of  the  reserve,  whereas  no  such  increase  could  be 
brought  about  with  safety  if  there  existed  only  a 
reserve  of  $31,578,947  against  $631,578,947  of  notes 
already  outstanding. 


Ssparate  Reserves  for  the  Notes 

Under  the  present  system  in  the  United  States 
the  only  special  reserve  for  the  outstanding  Na- 
tional-bank notes  is  the  5-per-cent.  redemption  fund 
deposited  with  the  Government,  and  this  5-per-cent. 
redemption  fund  is  counted  also  as  part  of  the 
minimum  reserves  of  the  banks  against  deposit 
liabilities.  In  fact,  each  bank's  general  reserve 
against  deposit  liabilities,  together  with  any  money 
in  its  5-per-cent.  note-redemption  fund,  constitutes 
the  bank's  reserves  for  the  payment  of  its  notes  as 
well  as  its  deposit  liabilities,  but  the  5-per-cent. 
redemption  fund  deposited  with  the  Government 
is  not  available  as  a  reserve  for  the  deposit  lia- 
bilities until  the  notes  shall  have  been  paid. 

For  several  reasons  this  system  is  bad.  A  re- 
serve of  5  per  cent,  would  be  utterly  inadequate  for 
an  elastic  issue  of  bank-notes — that  is  to  say,  an 
issue  that  can  be  contracted  as  well  as  expand- 
ed and  that  can  be  regulated  according  to   the 

94 


IN  THE  UNITED  STATES 

requirements  of  the  general  financial  situation. 
Under  the  present  system  the  5-per-cent.  redemp- 
tion fund  has  proved  adequate  only  because  the 
volume  of  the  outstanding  bank-notes  is  not  elastic 
and  does  not  fluctuate  rapidly,  but  constitutes 
what  has  been  described  as  a  "sodden  mass" 
added  to  the  currency  of  the  country.  If,  how- 
ever, the  general  reserves  of  the  banks,  together 
with  the  redemption  funds,  be  considered  as  re- 
serves for  the  outstanding  notes  and  the  deposit 
liabilities  combined,  the  present  system  in  the 
United  States  is  bad,  because  it  establishes  no 
relation  between  the  reserves  of  the  banks  and 
their  outstanding  note  issues.  Under  such  a 
system  no  intelligent  regulation  is  practicable. 

As  has  been  observed,  the  amount  of  the  reserve 
that  should  be  held  by  each  individual  bank,  with- 
out considering  the  general  credit  situation,  de- 
pends upon  the  nature  of  the  deposit  liabilities 
and  assets  of  the  particular  bank,  and  upon  its 
entire  business.  A  ratio  of  reserve  to  deposit  lia- 
bilities that  would  be  adequate  for  one  bank 
might  be  wholly  inadequate  for  another.  It 
would  be  utterly  impracticable  by  any  central 
authority  intelligently  to  fix  and  regulate  the  re- 
serve which  should  be  kept  by  each  of  the  seven 
thousand  individual  banks.  The  percentage  of  the 
reserve  of  each  individual  bank  in  relation  to  its 

95 


THE  BANKING  AND  CURRENCY  PROBLEM 

deposit  liabilities  can  be  regulated  intelligently 
only  by  the  managers  of  the  bank.  To  regulate  the 
general  credit  situation  from  time  to  time,  by  in- 
creasing or  by  diminishing  the  minimum  reserve 
requirements  of  all  the  banks  in  relation  to  their 
deposit  liabilities,  would  involve  the  application  to 
all  the  banks  of  a  uniform  rule  upon  a  subject 
which  ought  not  to  be  governed  by  a  uniform 
rule.  Furthermore,  it  would  be  quite  impossible 
to  enforce  an  order  from  a  central  authority 
directing  seven  thousand  banks  to  increase  the 
percentage  of  their  reserves  by  reducing  their 
loans,  their  discounts,  and  their  deposit  liabil- 
ities. 

The  better  plan  would  be  to  keep  separate  the 
reserves  for  outstanding  bank-notes  and  the  re- 
serves for  deposit  liabilities,  and,  without  attempt- 
ing to  change  and  to  regulate  the  reserves  for 
deposit  liabilities,  to  regulate  the  currency  and  the 
general  financial  situation  by  increasing  or  by 
diminishing  the  voltmie  of  oustanding  bank-notes 
and  the  percentage  of  reserve  for  the  notes.  The 
percentage  of  reserve  for  bank-notes  ordinarily 
should  be  larger  than  the  percentage  of  reserve  for 
deposit  liabilities,  especially  if  the  bank-note  issue 
is  elastic  and  serves  its  true  purpose  by  contracting 
and  expanding  according  to  financial  conditions. 
There  is  no  reason  why  all  the  banks  should  not 

96 


IN   THE   UNITED  STATES 

be  required  to  keep  a  uniform  percentage  of  reserve 
for  their  outstanding  notes. 

Of  course,  in  the  case  of  a  central  bank  there  is 
no  reason  for  separating  its  reserve  for  notes  from 
its  reserve  for  deposit  HabiHties,  because  the  man- 
agement of  the  central  bank  is  in  a  position  to  de- 
termine how  much  money  should  be  held  as  a 
reserve  for  the  outstanding  notes  and  how  much  as 
a  reserve  for  the  deposit  liabilities.  Accordingly, 
the  Bank  of  France  and  the  Imperial  Bank  of  Ger- 
many do  not  separate  the  reserve  for  notes  from 
the  reserve  for  deposit  liabilities.  The  Bank  of 
France,  with  a  large  note  issue  and  small  deposit 
liabilities,  keeps  on  hand  a  reserve  of  about  80  per 
cent,  of  its  combined  notes  and  deposit  liabilities. 
The  Imperial  Bank  keeps  a  reserve  of  about  40  per 
cent,  of  its  combined  notes  and  deposit  liabilities, 
but  it  is  required  to  keep  in  its  reserve  an  amount 
of  coin  equal  to  at  least  33^  per  cent,  of  its  note 
issues.  The  Bank  of  England,  on  the  other  hand, 
keeps  its  note-issue  department  entirely  distinct 
from  its  general  banking  department,  and  keeps  a 
separate  reserve  for  its  deposit  liabilities. 


Operation  of  the  Plan  Illtistrated 

The  operation  of  the  plan  may  be  illustrated  as 
follows:    Let  us  assume  that  the  association  of 

97 


THE  BANKING  AND  CURRENCY  PROBLEM 

banks  has  been  formed  and  that  all  arrangements 
have  been  made  to  commence  the  issue  of  notes, 
the  initial  percentage  of  the  note-redemption  fund 
having  been  fixed  at  40  per  cent.  A  demand  arises 
for  the  use  of  additional  currency  as  a  circulating 
medium  to  move  the  crops,  or  for  other  cause,  and 
depositors  commence  to  draw  lawful  money  from 
the  bank  reserves,  thereby  compelling  the  banks 
to  reduce  their  loans  and  discounts  and  to  raise  in- 
terest rates.  By  taking  out  and  issuing  notes  the 
banks  can  prevent  the  depletion  of  their  reserves 
and  the  necessity  of  largely  contracting  their  loans 
and  discounts,  because  for  every  $4,000  of  gold  or 
other  lawful  money  which  they  deposit  in  the  note- 
redemption  fund  they  can  issue  $10,000  in  notes. 

If  the  banks  should  put  in  circulation  notes  to 
the  aggregate  amount  of  $300,000,000  against  a 
deposit  in  the  redemption  funds  of  40  per  cent,  (or 
$120,000,000)  of  gold  or  other  lawful  money,  the 
currency  in  circulation  among  the  people  would  be 
increased  $300,000,000  while  the  general  bank  re- 
serves would  be  reduced  only  $120,000,000  by 
transferring  that  amount  to  the  note-redemption 
funds.  If  the  notes  had  not  been  issued  the  banks 
would  have  been  obliged  to  pay  $300,000,000  out 
of  their  lawful  money  reserves,  but  by  issuing  the 
notes  they  have  been  enabled  to  avoid  paying  out 
more  than  $120,000,000.     Thus  they  have  saved 

98 


IN  THE  UNITED  STATES 

$180,000,00  of  reserve  money  and  have  prevented 
a  reduction  of  their  credit  power  to  the  extent  of 
about  $1,000,000,000,  on  the  basis  of  the  average 
relation  between  the  deposit  liabilities  and  the  re- 
serves of  the  National  banks,  or  about  $2,000,- 
000,000  on  the  basis  of  the  average  of  all  the  banks 
and  trust  companies  of  the  country. 

Assume  then,  that,  in  consequence  of  a  diminu- 
tion of  business  activity,  $200,000,000  of  the 
$300,000,000  of  additional  currency  thus  put  in 
circulation  no  longer  is  needed.  Thereupon  sur- 
plus currency,  amounting  to  $200,000,000,  would 
be  deposited  in  the  banks ;  but,  the  notes  being  at 
a  parity  with  gold  and  other  lawful  money,  people 
wotild  not  pick  out  the  notes  and  deposit  the  whole 
$200,000,000  in  notes,  but  would  deposit  notes  and 
lawful  money  indiscriminately.  If  half  of  the 
$200,000,000  of  surplus  currency  so  deposited  were 
to  consist  of  bank-notes  and  the  other  half  of  law- 
ful money,  and  if  thereupon  the  banks  should  pre- 
sent the  $100,000,000  of  notes  for  redemption  in 
lawful  money,  then  from  time  to  time,  as  the  notes 
come  in  for  redemption,  the  board  of  managers  of 
the  association  would  call  upon  the  banks  having 
outstanding  notes  to  contribute  to  their  redemption 
funds  $60,000,000  additional  gold  or  other  lawful 
money,  the  other  $40,000,000  required  to  redeem 
the  $100,000,000  of  notes  having  been  deposited  for 

99 


THE  BANKING  AND  CURRENCY  PROBLEM 

that  purpose  in  the  redemption  funds  at  the  time 
of  issuing  the  notes.  Upon  redemption  of  the 
$100,000,000  of  notes  there  would  remain  still  out- 
standing $200,000,000  of  notes,  and  there  would  be 
in  the  redemption  fund  40  per  cent,  of  that  amount, 
or  $80,000,000  of  lawful  money.  The  general  re- 
serves of  the  banks  would  have  been  increased 
$100,000,000  by  the  deposit  of  that  much  lawful 
money. 

Increasing  bank  reserves  accompanied  by  a  very 
low  rate  of  interest  and  a  fall  in  the  cost  of  for- 
eign exchange,  and  possibly  by  exports  of  gold, 
would  indicate  to  the  board  of  managers  and 
to  the  Secretary  of  the  Treasury  the  need  of  a 
further  reduction  of  the  increase  of  the  currency 
caused  by  the  notes  remaining  in  circulation.  In 
that  event  the  board  of  managers,  in  conjunction 
with  the  Secretary  of  the  Treasury,  gradually 
would  increase  the  percentage  of  the  note-redemp- 
tion fund  from  40  per  cent,  to,  say,  60  per  cent. 
This  would  require  the  banks  having  outstanding 
notes  to  take  from  their  general  reserves  and  to 
deposit  in  their  note-redemption  funds  $40,000,00. 
of  additional  lawful  money,  being  20  per  cent,  of  the 
$200,000,000  of  notes  remaining  outstanding.  The 
effect  would  be  the  same  as  though  the  banks  had 
redeemed  and  cancelled  $40,000,000  of  the  notes  by 
paying  them  in  lawful  money  out  of  their  reserves. 

100 


IN  THE  UNITED  STATES 

The  note-redemption  fund  then  would  be  $120,- 
000,000  against  $200,000,000  of  outstanding  notes 
and  the  net  increase  of  the  currency  would  be 
$80,000,000.  If,  thereupon,  a  substantial  fall  in 
the  percentage  of  the  general  reserves  of  the  banks 
and  a  rise  of  interest  rates  and  of  the  cost  of  foreign 
exchange  should  indicate  an  increase  in  the  de- 
mand for  currency  as  a  circulating  medium,  or  in 
the  demand  for  bank  credits,  and  if  there  should  be 
no  signs  of  financial  disturbances  indicating  the 
need  of  a  restrictive  policy,  the  managing  board  and 
the  Secretary  of  the  Treasury  gradually  would  re- 
duce the  required  percentage  of  the  note-redemp- 
tion funds  from  60  per  cent,  to,  say,  40  per  cent. 
The  banks  then  could  withdraw  in  whole  or  in  part 
the  $40,000,000  of  surplus  in  the  note  redemption 
funds,  thereby  again  adding  that  amount  to  their 
general  reserves,  or  they  could  issue  additional 
notes  against  this  surplus.  The  $40,000,000  of 
surplus  in  the  note  -  redemption  funds  after  such 
reduction  of  the  required  percentage,  would  be  the 
basis  (at  40  per  cent.)  for  the  issue  of  $100,000,000 
of  additional  notes,  or,  if  withdrawn  by  the  banks 
and  added  to  their  general  reserves,  would  be  the 
basis  for  about  two  hundred  and  fifty  million 
dollars  of  additional  bank  credits,  according  to 
the  average  of  the  National  banks  alone,  or 
about  five  hundred   million   dollars,  according    to 


THE  BANKING  AND  CURRENCY  PROBLEM 

the  average  of  all  the  banks   and  trust  compa- 
nies. 

Of  course,  except  in  case  of  a  panic,  the  man- 
aging board  would  not  reduce  the  percentage  of 
the  redemption  funds  to  the  lowest  possible  point. 
In  normal  times  they  would  always  keep  the  per- 
centage of  the  redemption  funds  sufficiently  high 
to  furnish  a  basis  for  the  issue  of  a  substantial 
amount  of  additional  notes  to  meet  the  necessities 
of  a  panic  or  of  any  other  extraordinary  contin- 
gency. The  safest  situation  would  be  when  there 
is  a  considerable  note  issue  with  a  very  high  per- 
centage of  reserve,  as  in  France.  Though  the  Bank 
of  France  has  a  considerable  volume  of  notes  out- 
standing, usually  it  holds  a  reserve  equal  to  about 
80  per  cent,  of  its  combined  liabilities  for  deposits 
and  outstanding  notes. 


Uniform  or  Separate  Note  Issues  of  the  Banks 

The  proposed  plan  can  be  worked  out  either  by 
providing  for  separate  note  issues  of  the  several 
banks,  each  bank  being  required  to  keep  up  its 
separate  note-redemption  fund,  or  by  providing  for 
one  uniform  issue  of  notes  to  be  executed  by  the 
association,  with  a  joint  redemption  fund  to  be  kept 
up  by  pro  rata  contributions  of  the  several  banks. 

Under  the  plan  for  separate  note  issues,  the  notes, 
102 


IN  THE   UNITED  STATES 

having  been  prepared  and  registered  by  the  associa- 
tion, would  be  dehvered  to  the  banks,  which  then 
would  execute  and  issue  them,  as  in  case  of  the 
present  bond-secured  notes.  Under  this  plan  each 
bank  would  be  required  to  furnish  to  the  association 
and  to  keep  up,  at  the  prescribed  percentage,  its 
separate  redemption  fund  for  its  own  notes.  Upon 
presentation  of  the  notes  of  any  bank  for  redemption 
they  would  be  paid  out  of  the  redemption  of  that 
particular  bank. 

Under  the  plan  for  a  uniform  issue  of  notes  with 
a  joint  redemption  fund,  the  notes  would  be  all 
alike,  and  would  be  executed  by  the  oflficers  of  the 
association  and  be  delivered  to  the  banks  upon 
their  application.  Under  this  plan  all  the  banks 
would  be  required  to  provide  pro  rata  for  the  re- 
demption of  all  notes  that  are  presented  for  pay- 
ment and  would  be  credited  pro  rata  with  all  redemp- 
tions. The  association  would  keep  with  each  bank 
a  note  account  and  a  redemption-fund  account. 
Upon  taking  out  notes  a  bank  would  be  charged 
therewith  in  its  note  account,  and  it  would  be 
credited  in  its  redemption-fund  account  with  its 
contribution  to  the  fund,  such  contribution  being 
determined  by  the  percentage  at  which  the  fund 
then  stands.  At  the  close  of  each  business  day 
the  several  banks  would  be  credited  in  their  note 
accounts,  in  respect  of  all  notes  redeemed  on  that 

103 


THE  BANKING  AND  CURRENCY  PROBLEM 

day,  pro  rata  according  to  the  several  amounts  for 
which  they  stand  indebted  on  that  day  in  their 
several  note  accounts;  and  they  would  be  charged 
in  their  several  redemption-fund  accounts  with  pro 
rata  shares  of  the  money  paid  out  of  the  joint  fund 
in  redemption  of  these  notes.  Upon  any  call  for 
additional  contributions  to  the  joint  redemption 
fund  the  pro  rata  contributions  of  the  several  banks 
would  be  fixed  in  similar  manner. 

Under  either  plan  a  bank  could  discharge  its 
obligation  in  respect  of  all  or  any  of  the  notes  for 
which  it  is  responsible,  either  by  depositing  law- 
ful money  for  the  redemption  of  the  notes  or  by 
surrendering  notes  for  cancellation.  Under  the 
plan  for  separate  note  issues,  a  bank  surrendering 
all  or  any  of  its  own  notes  for  cancellation  could 
withdraw  its  note  -  redemption  fund  or  a  ratable 
part  thereof.  Under  the  plan  for  a  uniform  issue 
of  notes,  a  bank  surrendering  any  outstanding 
notes  could  withdraw  a  proportionate  share  out  of 
the  joint  redemption  fund.  After  having  sur- 
rendered for  cancellation  the  whole  amount  of 
notes  for  which  it  stands  indebted  to  the  asso- 
ciation, a  bank,  like  any  other  noteholder, 
could  present  notes  for  payment  and  redemp- 
tion. 

Under  either  plan,  from  time  to  time  a  bank 
could  take  out  additional  notes,  as  the  amount  of 

104 


IN  THE  UNITED  STATES 

notes  for  which  it  is  indebted  to  the  association  is 
reduced  by  redemptions  or  by  the  surrender  of 
notes,  but  the  amount  of  notes  for  which,  at  any 
one  time,  a  bank  may  be  indebted  would  be  limited 
as  provided  in  the  statute. 

The  only  material  difference  between  the  two 
plans  is  that,  in  case  of  separate  note  issues  with 
separate  redemption  funds,  each  bank  would  have 
to  provide  for  the  redemption  of  its  own  notes 
whenever  they  come  in  for  redemption,  while  under 
the  plan  for  a  uniform  note  issue  with  a  joint  re- 
demption fund  every  redemption  of  notes  would 
be  treated  as  a  redemption  of  only  a  pro  rata  part 
of  the  notes  for  which  each  bank  is  chargeable. 
The  ultimate  responsibility  of  the  several  banks 
would  be  the  same  under  both  plans. 

The  plan  for  a  uniform  note  issue  with  a  joint 
redemption  fund  probably  would  be  simpler,  less 
expensive,  and  easier  to  administer  than  the  plan 
for  separate  note  issues  and  separate  redemption 
funds;  but  it  would  require  careful  consideration 
by  experienced  bankers  whether  the  plan  for  a 
uniform  note  issue  and  a  joint  redemption  fund 
would  prove  fair  to  all  the  banks.  On  the  one 
hand,  it  may  be  said  that  it  would  be  largely  a 
matter  of  accident  whether  the  notes  issued  by  a 
particular  bank  remain  in  circulation  a  long  time 
or  a  short  time,  and,  therefore,  that  it  would  be  fair 
8  105 


THE  BANKING  AND  CURRENCY  PROBLEM 

to  all  the  banks  to  apply  all  redemptions  of  notes 
pro  rata  according  to  the  amount  of  notes  put  in 
circulation  by  each  bank.  On  the  other  hand,  it 
would  be  necessary  to  guard  against  the  possibility 
of  a  bank  increasing  its  general  reserves  of  lawful 
money  by  presenting  notes  for  payment  out  of  the 
joint  redemption  fund  while  the  bank  remains  in- 
debted to  the  association  for  outstanding  notes. 
For  example,  if  a  bank  could  take  out  notes,  and, 
directly  or  indirectly,  could  cause  these  notes  to 
be  presented,  in  its  behalf,  for  payment  out  of  the 
joint  fund,  it  might  thus  increase  its  general  reserves 
by  drawing  lawful  money  from  the  joint  redemp- 
tion fund  to  which  all  the  banks  would  have  to 
contribute  ratably.  However,  the  advantage  would 
be  only  temporary,  inasmuch  as  the  bank  taking 
out  notes  and  causing  them  to  be  redeemed  would 
receive  credit  only  for  the  redemption  of  its  pro 
rata  share  of  these  notes.  It  would  still  remain 
liable  for  the  balance,  less  only  the  part  thereof 
represented  by  its  contributions  of  lawful  money 
to  the  joint  redemption  fund,  and  it  would  have  to 
make  future  contributions  to  the  joint  redemption 
fund  until  it  shall  have  extinguished  the  whole 
of  this  liability  either  by  contributions  of  law- 
ful money  or  by  surrendering  notes  for  cancella- 
tion. 


1 06 


IN  THE  UNITED  STATES 

Security  of  the  Notes 

It  is  a  matter  of  primary  importance  that  an 
issue  of  bank-notes  shall  be  absolutely  good  and  be 
kept  at  a  parity  with  lawful  money ;  in  other  words, 
that  the  notes  will  be  redeemed  certainly  in  gold 
or  other  lawful  money  whenever  presented  for  pay- 
ment. While  bank  depositors  generally  can  look 
out  for  their  own  interests  and  may  voluntarily  take 
the  risks  of  unwise  management  of  the  institutions 
with  which  they  deal,  bank-notes  would  fail  to 
serve  their  purpose  as  a  circulating  medium  if  it 
were  necessary  in  each  instance  to  scrutinize  the 
solvency  of  the  banks  issuing  them.  Bank-notes 
that  fluctuate  in  value  or  that  may  prove  worthless, 
as  in  the  days  of  our  "wildcat  banks,"  woiild  cause 
loss  to  innocent  people  throughout  the  country, 
and  would  be  fatal  to  business  prosperity  generally. 
Therefore,  clearly,  it  is  the  duty  of  the  Government 
to  prevent  the  issue  of  bank-notes  for  use  as  cur- 
rency unless  the  payment  of  such  notes  on  demand 
be  assured  beyond  a  doubt. 

One  of  the  most  dangerous  fallacies  in  banking 
is  the  idea  that  a  deposit  of  ample  security  in  the 
form  of  bonds  or  anything  else  is  sufficient  to  make 
an  issue  of  bank-notes  sound  and  safe.  It  is  all  im- 
portant that  bank-notes  shall  be  convertible  on  de- 
mand into  lawful  money.     An  issue  of  bank-notes 

107 


THE  BANKING  AND  CURRENCY  PROBLEM 

is  unsound  and  unsafe  and  will  fail  to  serve  its  pur- 
pose, unless  the  holders  of  the  notes,  at  all  times, 
can  count  with  certainty  upon  obtaining  gold  or 
other  lawful  money  for  the  notes  on  demand.  It 
is  quite  as  important  that  the  banks  should  keep 
reserves  of  lawful  money  for  the  payment  of  their 
notes  as  for  the  payment  of  their  deposit  liabilities ; 
and  if  an  issue  of  bank-notes  is  really  an  elastic  one, 
so  that  it  will  contract  promptly  with  the  cessation 
of  the  need  for  notes,  prudence  requires  that  the 
reserves  of  lawful  money  kept  for  the  notes  shall  be 
larger  than  the  reserves  for  deposit  liabilities.  It 
is  to  be  observed,  also,  that  the  position  of  all  the 
banks  collectively  would  not  be  strengthened  by 
providing  collateral  security  for  bank-note  issues 
even  though  the  security  were  to  consist  of  Govern- 
ment bonds  for  which  there  is  a  ready  market.  A 
purchaser  of  the  bonds  would  have  to  draw  from 
some  bank  the  money  to  pay  the  purchase  price. 
The  money  realized  by  selling  the  bonds  of  the  bank 
in  default  would  be  obtained  by  reducing  the  reserve 
of  some  other  bank. 

Under  the  plan  now  proposed  the  security  for 
the  payment  of  the  notes  on  demand  in  lawful 
money  would  be  as  follows : 

(a)  A  redemption  fund,  consisting  of  gold  or 
other  lawful  money,  amounting  to  a  substantial 
percentage  of  the  notes; 

1 08 


IN  THE  UNITED  STATES 

(6)  The  individual  obligation  of  each  bank  to 
redeem  the  amount  of  notes  issued  by  it  and  to 
keep  up  its  redemption  fund  for  that  purpose; 

(c)  A  safety  fund  to  be  created,  as  hereinafter 
explained,  by  a  tax  to  be  paid  by  each  bank  on  the 
amount  of  notes  it  has  outstanding  in  excess  of  the 
lawful  money  in  its  note-redemption  fund; 

(d)  A  deposit  of  United  States  bonds  by  those 
banks  choosing  to  deposit  bonds  as  security  for 
such  excess,  in  order  to  obtain  the  benefit  of  the 
lower  tax  upon  notes  so  secured;  and 

(e)  The  ultimate  ratable  liability  of  all  the  issuing 
banks. 

The  notes  issued  under  this  plan  would  be  safer 
than  any  bank-notes  in  the  world,  except  possibly 
the  notes  of  the  Bank  of  England.  If,  to  increase 
popular  confidence  in  the  notes,  it  should  be  deemed 
advisable  that  they  be  guaranteed  by  the  United 
States,  there  is  no  reason  why  the  United  States 
should  not  practically  guarantee  their  payment  and 
make  them  receivable  in  payment  of  taxes  and 
excises  and  other  dues  to  the  United  States,  as  in 
case  of  the  present  bond-secured  notes.  The  issue 
of  the  notes  would  be  supervised  and  controlled  by 
the  Government.  A  guarantee  of  their  payment 
would  subject  the  United  States  to  less  risk  than  the 
present  bond-secured  notes,  because  under  the  pro- 
posed plan  the  notes  would  be  backed  by  adequate 

109 


THE  BANKING  AND  CURRENCY  PROBLEM 

redemption  funds  of  lawful  money,  which  all  the 
banks  would  be  bound  to  keep  up  at  all  times  by- 
importations  of  gold  if  necessary.  Under  the 
present  system  the  Government  is  bound  to  pay 
the  notes  of  the  banks  on  demand  in  gold  or  other 
lawful  money.  If  the  Government  should  not  have 
in  the  Treasury  the  required  amount  of  gold  or 
other  lawful  money,  and  if  the  banks  should  fail 
promptly  to  reimburse  the  Government  for  the 
payment  of  their  notes,  the  Government  would 
have  to  sell  bonds  or  borrow  the  required  amount  of 
gold.  The  United  States  bonds  deposited  as 
collateral  for  the  bond-secured  notes  would  cease 
to  afford  adequate  security  if  the  artificial  value  of 
these  bonds  should  be  impaired  by  the  issue  of 
additional  Government  bonds,  as  might  happen  in 
case  of  a  war.  The  present  artificial  value  of  these 
bonds  is  caused  only  by  their  limited  supply  and  by 
the  demand  of  the  banks  for  such  bonds  as  a  basis 
for  the  issue  of  bond-secured  notes. 


Collateral  Security 

Collateral  security  would  not  be  needed  to  pro- 
tect the  associated  banks  against  loss  by  reason  of 
defaults  of  individual  banks  in  keeping  up  their 
note-redemption  funds,  because  the  experience  of 
forty  years  proves  that  the  losses  through  failures  of 


IN  THE  UNITED  STATES 

individual  banks  would  be  infinitesimally  small  and 
that  the  safety  fund  would  be  many  times  more 
than  sufficient  to  cover  any  losses. 

Collateral  security,  no  matter  how  good,  is  in  no 
sense  a  substitute  for  gold  or  lawful  money  as  a 
reserve  for  the  payment  of  bank-notes  which,  on 
demand,  must  be  paid  in  cash.  Collateral  would  be 
security  only  for  the  ultimate  payment  of  the  notes 
and,  for  the  reasons  already  stated,  is  unnecessary 
for  that  purpose. 

It  would  not  be  practicable  to  furnish  security  in 
the  form  of  commercial  paper,  because  a  central 
agency  could  not  pass  intelligently  upon  the  charac- 
ter of  such  paper,  or  satisfactorily  administer  collat- 
erals consisting  of  commercial  paper  maturing  from 
day  to  day.  It  would  not  be  practicable,  through 
a  central  agency,  to  collect  the  maturing  paper  and, 
in  case  of  non-payment,  to  notify  indorsers  and  en- 
force payment  or  arrange  for  extensions,  etc.  It 
would  be  inadvisable  to  make  municipal  bonds  or 
bonds  of  private  corporations  receivable  as  collat- 
eral, partly  because  of  the  complications  which 
would  ensue  if  any  board  were  vested  with  a  dis- 
cretionary power  to  pass  upon  such  securities,  and 
partly,  also,  because  an  artificial  value  would  be 
given  to  such  securities  by  making  them  receivable 
as  collateral  for  bank-notes.  The  right  to  issue 
the   present    bond-secured    notes    against    United 

III 


THE  BANKING  AND  CURRENCY  PROBLEM 

States  bonds  has  given  to  these  bonds  an  artificial 
value,  probably  at  least  20  per  cent,  in  excess  of 
their  real  value  as  investments,  and  consequently 
the  holders  of  United  States  bonds,  including  the 
banks,  consider  now  that  this  artificial  value  is  a 
vested  right  that  should  be  protected  by  law.  If 
municipal  bonds  or  other  bonds  were  made  re- 
ceivable as  collateral  security  for  bank-note  issues, 
these  bonds,  likewise,  soon  would  acquire  an  ar- 
tificial value,  and  it  would  be  claimed  that,  in 
justice,  this  artificial  value  should  not  be  im- 
paired by  any  subsequent  change  of  the  currency 
laws. 

However,  though  it  is  undesirable  and  unwise 
to  require  collateral  security  for  an  issue  of  bank- 
notes, some  of  the  objections  that  have  been  raised 
against  collateral  security  for  bank-notes  appear 
to  be  unfounded.  Thus  it  often  has  been  contended 
that  the  present  issue  of  bond-secured  National- 
bank  notes  is  inelastic  because  United  States  bonds 
must  be  deposited  as  security  for  such  notes.  This 
appears  to  be  a  mistake.  The  true  reason  why 
the  issue  of  these  bond-secured  notes  is  inelastic  is 
that  each  one  of  the  seven  thousand  banks  at  all 
times  issues  and  keeps  outstanding  all  the  notes 
it  can,  guided  only  by  the  desire  to  make  a  profit 
for  itself  and  regardless  of  the  credit  situation  of 
the  whole  country.     An  issue  of  notes  simply  upon 

112 


IN  THE  UNITED  STATES 

the  credit  of  the  banks,  without  collateral  security, 
would  be  equally  inelastic  unless  regulated  and  con- 
trolled through  some  central  authority  by  increas- 
ing or  diminishing  the  required  reserve  for  the 
notes. 

Again,  it  has  been  contended  that  if  the  banks 
deposit  bonds  as  collateral  security  for  their  notes, 
they  must  use  part  of  their  capital  in  paying  the 
purchase  price  of  the  bonds,  and  that  this  would 
diminish  the  amount  of  capital  or  credit  of  the  banks 
available  for  the  accommodation  of  the  commercial 
business  of  the  country.  This  appears  also  to  be 
a  mistake.  When  a  bank  invests  in  bonds  to  be 
used  as  collateral  for  notes  of  the  bank  the  money 
paid  for  the  bonds  is  not  locked  up  or  taken  out  of 
circulation,  but  remains  in  the  country,  and  re- 
mains available  as  circulating  currency  and  as 
bank  reserves.  The  only  lawful  money  that  may 
be  locked  up  under  the  present  laws  is  the  5  per 
cent,  of  the  notes  to  be  deposited  in  lawful  money 
with  the  Government,  and  even  that  money  is  not 
necessarily  locked  up,  as  the  law  requires  it  to 
be  turned  into  the  Treasury  as  a  miscellaneous  re- 
ceipt. On  the  other  other  hand,  there  is  an  actual 
increase  of  the  circulating  currency  by  the  amount 
of  the  notes.  To  the  extent  that  these  notes  are 
used  as  a  circulating  medium,  they  save  the  use 
of  that  much  lawful  money,  which  goes  into  the 

113 


THE  BANKING  AND  CURRENCY  PROBLEM 

bank  reserves  and  becomes  available  as  a  basis  for 
granting  additional  bank  credits. 

Protection  of  United  States  Bond  Valties 

There  has  developed  a  sentiment  that  any  cur- 
rency legislation  that  may  be  passed  should  con- 
tain such  provisions  as  will  preserve  the  artificial 
value  heretofore  given  to  Uinted  States  bonds  by 
making  them  available  as  security  for  the  issue  of 
National  -  bank  notes.  In  order  to  protect  this 
artificial  value  of  United  States  bonds  it  should  be 
provided  that  any  bank  issuing  notes  under  the 
plan  now  proposed  shall  have  the  privilege  of  de- 
positing United  States  bonds  as  collateral  security 
for  the  uncovered  part  of  the  notes,  and  that  in 
consideration  of  furnishing  such  security  (which 
would  protect  the  safety  fund  and  the  other  banks 
from  ultimate  loss)  the  banks  making  such  deposit 
of  United  States  bonds  shall  pay  only  the  present 
taxes  upon  their  circulation  so  secured,  and  shall 
be  relieved  from  the  higher  taxes  to  be  imposed 
upon  notes  issued  without  such  collateral  security. 

Taxation  of  Notes  ttnder  the  Plan 

In  fixing  the  rate  of  the  tax  to  be  imposed  upon 
the  proposed  circulation,  the  following  considera- 
tions should  be  borne  in  mind : 

114 


IN  THE  UNITED  STATES 

(a)  Bank  credits  and  bank-notes  are  merely  part 
of  the  machinery  for  transacting  business,  and  this 
machinery  should  not  be  made  unnecessarily  ex- 
pensive to  the  people  by  taxation  or  by  other 
artificial  means.  Ultimately  a  high  tax  upon 
bank  credits  or  currency  would  fall  upon  bor- 
rowers and  would  operate  as  a  check  upon  busi- 
ness generally. 

(6)  A  tax  upon  bank-notes  or  bank  credits  is 
not  required  to  obtain  revenue  for  the  Govern- 
ment. 

(c)  Taxation  is  neither  a  scientific  nor  an  effect- 
ive method  of  regulating  bank  credits  or  of 
keeping  the  banks  sound  and  the  currency  safe. 
The  right  way  to  prevent  an  issue  of  bank-notes 
from  causing  an  unsafe  expansion  of  bank  cred- 
its is  by  requiring  the  banks  to  increase  the  re- 
serve for  the  redemption  of  the  notes,  thereby 
diminishing  the  amount  of  notes  outstanding  in 
excess  of  this  reserve.  If  it  be  desirable  to  re- 
duce the  profits  derived  by  the  banks  from  their 
note  issues,  the  proper  way  to  accomplish  this  is 
to  compel  the  banks  to  reduce  the  uncovered 
amount  of  the  notes  by  increasing  the  redemption 
fund  or  reserve  for  their  payment.  Though  taxa- 
tion of  bank-notes  may  restrict  the  issue  of  bank- 
notes, it  cannot  add  to  their  security  or  strengthen 
the  situation  of  the  banks. 


THE  BANKING  AND  CURRENCY  PROBLEM 

(d)  A  small  tax  upon  bank-notes  for  the  purpose 
of  providing  a  safety  fund  for  the  payment  of  the 
notes  of  defaulting  banks  is  proper,  and,  as  shown 
by  present  experience  in  Canada  and  by  former  ex- 
perience in  New  York,  such  a  safety  fund  would 
accomplish  its  purpose. 

(e)  A  tax  upon  bank-notes  should  be  based  upon 
the  portion  of  the  notes  not  covered  by  gold  or  other 
lawful  money  in  the  note  -  redemption  fund.  It 
should  not  be  based  upon  the  nominal  amount  of  the 
notes  outstanding,  for  a  considerable  issue  of  notes 
with  a  large  percentage  of  gold  or  other  lawful 
money  in  the  redemption  fund  is  better  and  safer 
than  a  small  issue  of  notes  with  a  smaller  percentage 
of  reserve.  It  is  only  the  uncovered  part  of  a  note 
issue  that  represents  an  increase  of  the  currency 
based  upon  the  credit  of  the  banks. 

Having  regard  to  these  considerations,  it  is  pro- 
posed that  each  bank  be  required  to  pay  quarterly 
a  tax  computed  at  the  following  rates  on  the  aver- 
age amount  of  notes  it  has  outstanding  in  excess  of 
the  average  amount  of  gold  or  other  lawful  money 
in  its  note-redemption  fund — viz. : 

(i)  At  the  rate  of  one-half  per  cent,  per  annum 
on  so  much  of  such  excess  as  is  secured  by  a  de- 
j)osit  of  United  States  2-per-cent.  bonds. 

(2)  At  the  rate  of  i  per  cent,  per  annum  on  so 
much  of  such  excess  as  is  secured  by  United  States 

116 


IN  THE  UNITED  STATES 

bonds  bearing  interest  at  a  rate  greater  than  2  per 
cent. 

(3)  At  the  rate  of  3  per  cent,  per  annum  on  any 
remainder  of  such  excess. 

These  taxes,  or  part  of  them,  should  be  set  apart 
for  use  as  a  safety  fund  to  be  applied  in  making 
good  any  losses  through  default  of  banks  in  keeping 
up  their  note-redemption  funds. 


Existing  Bond-Secured  Notes 

The  uncovered  amount  of  bank-notes  now  out- 
standing in  the  United  States  is  larger  in  proportion 
to  the  total  currency  of  the  country,  and  in  pro- 
portion to  population,  than  is  the  uncovered 
amount  of  bank-notes  outstanding  in  England, 
France,  or  Germany.  Experience  has  shown  that 
the  volimie  of  bank-notes  outstanding  in  the  United 
States  is  too  large,  except  when  an  extraordinary 
amount  of  currency  is  needed  for  circulation,  or 
when  there  is  a  bank  panic.  In  order  to  place 
financial  conditions  in  the  United  States  upon  a 
sound  basis,  it  is  necessary  that  any  increase  of  the 
present  inelastic  volume  of  bank-notes  be  stopped. 
No  plan  can  be  sound  that  provides  merely  for  the 
issue  of  more  bank-notes  on  top  of  the  present 
bond-secured  notes.  No  plan  can  be  sound  unless 
it  shall  provide  for  elasticity  in  the  uncovered  volume 

117 


THE  BANKING  AND  CURRENCY  PROBLEM 

of  bank-notes,  so  that  an  excessive  amount  of  the 
notes  shall  not  remain  outstanding  in  normal  times. 

After  some  years,  owing  to  the  growth  of  the 
country  in  population  and  in  wealth,  the  present 
volume  of  bank-notes  probably  would  cease  to  be 
excessive  even  in  normal  times,  but  it  is  very  de- 
sirable that  at  least  a  portion  of  the  bond-secured 
notes  be  replaced,  as  soon  as  possible,  by  an  issue  of 
notes  that  can  be  contracted  in  normal  times  by 
some  central  authority.  It  is  proposed  to  bring 
about  this  resiilt  as  follows  : 

(a)  No  United  States  bonds  hereafter  issued  shall 
be  receivable  as  security  for  bond-secured  notes 
under  existing  laws. 

(6)  No  bank  being  a  member  of  the  proposed  as- 
sociation shall  be  permitted  to  issue  bond-secured 
notes  under  the  existing  laws  to  an  amount  ex- 
ceeding 50  per  cent,  of  its  capital  stock.  If  any 
such  bank  at  the  time  of  becoming  a  member  of  the 
association  shall  have  outstanding  notes  issued  im- 
der  existing  laws  to  an  amount  exceeding  50  per 
cent,  of  its  capital  stock,  such  bank  shall  not  be 
allowed  to  issue  notes  under  existing  laws  upon  re- 
demption of  any  of  such  outstanding  notes  until  the 
amoimt  of  these  notes  issued  pursuant  to  existing 
laws  shall  be  reduced  below  50  per  cent,  of  the 
capital  stock  of  the  bank. 

(c)  After  the  satisfactory  operation  of  the  plan 
118 


IN  THE   UNITED  STATES 

shall  have  been  established,  further  restrictions 
should  be  imposed  upon  the  issue  of  bond-secured 
notes  under  the  existing  laws,  so  as  to  force  the 
gradual  substitution  of  notes  issued  under  the  pro- 
posed plan  for  the  present  bond-secured  notes. 

The  banks  would  be  protected  against  loss  re- 
sulting from  a  forced  reduction  of  their  issues  of 
bond-secured  notes,  because  they  would  acquire  the 
right  to  issue  notes  under  the  new  plan  and  could 
use  their  United  States  bonds  as  collateral  for  the 
uncovered  part  of  these  notes,  thereby  saving  the 
higher  taxes  which  would  be  payable  by  those 
banks  that  do  not  deposit  United  States  bonds. 


THE    END 


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